The government has to match some of its tough rhetoric on banks if public opinion is going to weather the spending review. But simple retribution won't do.
By Peter Wozniak
George Osborne yesterday had to abort his big meeting with the heads of Britain's biggest banks, becoming another victim of the snow chaos. But the fraught relationship between government and the financial sector is still going to need some clarity - and soon.
Recently we've seen more and more tough rhetoric being promulgating on bankers' bonuses by the coalition, particularly Liberal Democrat ministers. We've had Vince Cable mooting the possibility of tax rises if there is an "excessive" bonus round this Christmas. Nick Clegg has lambasted as "unacceptable" the sight of bankers reaping huge rewards while ordinary people are struggling with the burden of vast cuts to public spending. Even the Conservative leadership have been jumping on the banker-bashing bandwagon.
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But what have we actually seen in terms of action? The standard government response, pointing out the £2 billion levy on the banks, has assuaged the intense anger over the issue for now, but it won't cut the mustard for long.
The coalition asks people to come with them on the spending cuts journey, with the infamous (and inaccurate) claim: 'We're all in this together'. Some of the rhetoric must be matched by reality if the government is not going to suffer a fatal loss of public confidence. The status quo won't do at all.
The government will be able to tap into huge veins of public sympathy by indulging in a draconian crackdown, with gargantuan taxation and pay restrictions. The temptation to follow the public mood must be extremely strong.
The arguments of the leading banks, meanwhile, go something like this: Cracking down on bonus activity will drive away the very best 'talent', making London less attractive as a financial centre, encouraging the biggest organisations to scarper to the safety of low-tax Switzerland and Jersey - and therefore depriving the country of a large proportion of its tax revenue.
Those arguments sound increasingly shrill. They are not entirely without merit, however.
The central point that the government needs a coherent position on banks, and that position needs to show banks taking their share of the cuts pain, stands. But there are very good reasons for not wantonly launching into extreme measures on the banking system.
To be clear, I am categorically not trying to justify the culture of bankers bonuses, nor am I suggesting the government should simply kow-tow to bankers' threats to flee the country if their demands on low taxation and regulation are not met and offer no reform at all.
We do, however, have to deal with our economy as it is and not as we would wish it - at least not yet. And the reality is that we still need the financial sector to drive private-sector recovery for the time being.
It is certainly true that banks have been lax on lending to the small and medium-sized businesses the government is relying on to drive growth. They may well need to be pushed into it. But at the end of the day that capital will have to come via UK banks. It will do no good to pile on so much regulation to make banks hoard capital that the economy freezes up once more.
The temptation to show no mercy to the banking system is strong and much of it is justified. The notion that we should continue to rest the foundations of our economy on a sector that has brought about deep recession, threatened the collapse of the market and necessitated such levels of government intervention that we are now the reluctant owners of the largest peace-time deficit in history is plainly ridiculous.
I would love to be able to bring about the holy grail of 'rebalancing the economy', but it won't happen overnight by imposing dreadful sanctions on these much-hated institutions. Action on the banks needs to be serious. It also needs to be based on a long-term economic strategy, rather than the temptations of short-term politics.
The threat of an exodus is wholly irresponsible and unfortunately serious. A balance must be found between curbing the bonus culture while the spending review is ongoing and keeping Britain competitive for financial services.
Re-introducing Labour's surprisingly effective 'bonus tax' should be seriously considered if Christmas bonuses at taxpayer-owned banks are as generous as feared.
Far more important though is the government's response to the independent commission on the future of the financial sector - due next year.
The key problem which that commission should consider lies in the fact that banking is an international affair. Strict reform in the UK will not stop bad banking practices. It will simply shift them overseas and deprive us of some much-needed tax revenue.
What is needed is an international agreement on financial regulation which would have to be a work of such diplomatic expertise as has never yet been seen. The seeds of such an approach could conceivably be laid as governments around the world come to terms with the real consequences of the financial crisis in their own budgets.
The motto of such an agreement ought to be: 'If your quarry threatens to go to ground, leave no ground to go.' It will be easier said than done, and will have to be accompanied by an equally unprecedented shift in attitude towards tax havens.
Closer to home, a key plank of potential British policy being pushed for by business secretary Vince Cable is the separation of the retail and investment portions of banks. On paper, this sounds like an ideal solution. Banks will no longer be 'too big to fail' and the taxpayer would be insulated from the riskier activities of investment banking.
Cable was criticised for his speech earlier in the year on the nature of capitalism. The problem with banking is proper capitalism does not operate. Rather it is run by a small cartel of vast institutions devoid of the competitive pressures necessary to avoid the system spiralling out of control.
Such a separation would be heavily resisted by the biggest banks, making the kind of international work described above all the more significant. Britain cannot go it alone on banking reform.
The government's response does need to deal with the irresponsible bonus culture, if only to dampen public anger on the issue, but far more important is the structure of the banking system itself.
To quote David Cameron: 'We can't go on like this'. Eventually governments, particularly in Britain, will have to reduce their reliance on the industry for rapid growth. In the meantime though, the coalition will have to listen to the dictates of the long-term. Reducing Britain's vulnerability to a similar financial crisis in future should be paramount in ministers' minds.
Neither the shrill threats of the industry to abandon Britain nor the angry calls for an unrealistically heavy crackdown should dominate this debate.
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