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Between the lines of the independent commission on banking interim report

April 14, 2011

This post is duplicated on the IDEA centre’s Professional Ethics Network blog here.

In June last year the Chancellor of the Exchequer, George Osborne, set up an independent commission to investigate the UK banking sector in the light of the financial crisis that began in 2007. At the beginning of this week it published its interim report, with the final version due in September this year. If you don’t feel like reading the whole report Robert Peston has provided some intelligent thoughts on it as well as a summary of its contents on his BBC blog.

My aim here is not to summarise what the report says but rather what it doesn’t, at least not explicitly. In particular, I’m interested in what considerations are really driving the commission’s recommendations and why it is important that we recognise and reflect upon them. These considerations, it seems clear, are threefold:

  1. The generation of social benefit
  2. The distribution of this benefit between different parties
  3. The risks inherent in any given course of action

The terms of reference handed to the commission by the government focus on two specific aims: the promotion of financial stability and the promotion of competition. However, neither of these things are valuable in themselves, only for what they represent or can bring about. The question of why we want financial stability and competition in the banking industry is only tackled obliquely in the commission’s report, yet plenty of information is there. In discussing the need for reform in the UK banking sector in chapter 2 it refers to the ‘catastrophic social and economic impact’ of a major disruption to the retail payments system (§2.13); the ‘high social cost of bank insolvency’ (§2.14); the severe effects on the UK of the crisis (§2.23); the need to ‘protect the economy, and the taxpayer, from significant harm’ (§2.26); and the importance of promoting efficiency, leading to lower costs and better products for customers (§2.52).

While this idea of the promotion of social benefit is a clear thread that runs through the report, a less obvious yet distinct motivation can also be detected. This second motivation is less concerned with the total benefits being generated and more on how they are distributed: for example that remuneration levels for employees in wholesale and investment banking indicate that competition is working badly for customers (§2.82); and that ‘determining the extent to which costs and benefits accrue privately as opposed to socially’ (§2.93) is taken to be important – a concern which is mirrored at various points (§4.11, §4.40, §4.68, §4.105).

These two underlying concerns – of promoting social benefit and determining how it is distributed – may be interesting, but why is it important that we recognise them? First of all, it allows us to notice that we must separate out another important factor – the risks involved in any given course of action. The management of risk is another idea central to the report and it might be tempting to think that this is just another part of social benefit and its distribution; of course incorporating risk into an assessment of social benefit is possible (assuming we can quantify it in some way), but this exercise would assume that we already have an agreed attitude to risk that we can apply to such an assessment. And there is no reason for thinking that such an agreement exists – the appropriate attitude to risk is another question we must answer, and so risk must be separated out as a distinct factor against which the options in the report can be judged.

Pointing out this complication, however, only serves to illustrate other reasons to think more about the fundamental considerations driving the report’s recommendations. If the underlying concerns really are the promotion of social benefit, how this benefit is distributed, and the management of risk, it seems reasonable to ask what the exact relation is between promotion of stability and competition and these desirable outcomes; and we will only be able to answer this question if we know what such outcomes look like in practice. It is not that the report does not tackle this question, it is rather that it does it implicitly. It is thus hard to examine these underlying assumptions to determine whether they are ones we should accept.

‘Social benefit’ is most easily understood in terms of impact on UK GDP and certainly ‘benefit’ is taken throughout the report to be quantifiable (at least in theory) in financial terms (see, for example, Annex 3). This may well be entirely reasonable in this context, but it is not the only possible way to think about social benefit, and so this assumption should be spelt out. Equally, at the points where distribution is considered the implication is that the issue at stake is one of equity (e.g. §2.15) – yet there are different ways of understanding what ‘equity’ requires in any given situation and unexamined assumptions in this area are only likely to store up potential for disagreement and confusion.

On the other hand, as is illustrated at numerous points in the report, any given recommendation stands to generate a number of quite distinct outcomes. For example, take measures to improve banks’ stability (e.g. §4.3). By reducing the risk of financial disaster, such measures generate social benefit; however, insofar as they increase the private costs to banks and reduce their international competitiveness they threaten this benefit. Moreover, all these effects are uncertain – that is, they come with associated risks. Finally, the distributional effects of such measures are certainly not neutral particularly, for example, where they involve removing an implicit government (and hence taxpayer) guarantee protecting financial institutions.

It is not my intention to be critical of the report, indeed I am not in a good position to comment one way or another on how successful its recommendations would be in achieving its stated aims. What I hope to have highlighted, however, is that we need to think more carefully and more clearly about how these aims should be interpreted at the most fundamental level. At present this discussion is at best implied, at worst unclear. Armed with this further information we stand a better chance of asking, and answering, the most important questions of all in an area that the last few years have shown to be of vital importance to all of us.


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