Fifty years of changing banking has seen more good than bad.
Peter D. Hahn
Henry Grunfeld Professor of Banking.
In late 2008, after the nationalisation of Royal Bank of Scotland and substantial government assistance to Lloyds in its rescue of Halifax Bank of Scotland, I was requested to answer questions on bank bonuses before the House of Commons Treasury Select Committee (TSC). I was an aspiring academic with a recent PhD coincidently focused on corporate governance and remuneration, but also a former banker who had worked in commercial and investment banking and received bonuses. The hearing was televised and accessible globally and I supported the concept of bankers’ bonuses; I received a good deal of hate mail from around the globe following, perhaps to no surprise with the amount of taxpayers’ money going to rescue banks in the UK, USA, and much of Europe. Yet, a few listened as I got in some detail on why the existing bonus system didn’t work: poorly structured, calibrated, governed with the wrong incentives. I also noted that, if executed correctly, the flexibility to not pay bonuses was a financial safeguard for challenged banks. The devil was in the detail.
The crisis and the continuing surfacing of incidents of poor behaviour at major and minor banks have resulted in much banking nostalgia and longing for those ‘good ole banking days’ of the 20th century with memories of banks as the “Pillars” of society in this book’s title, but were they really? In these days of rapidly reducing numbers of bank branches, I often hear “it was so much easier to go in and speak with someone.” Yet, early in my career, banks were largely open from ‘9-5’ when I had a job to do, if not fewer hours, and I often needed to spend most of my lunch break queueing to deposit my pay cheque. If one ran out of cash on Thursday, you might as well forget lunch on Friday with its extra-long waits to get to the counter. Weekends could find closed branches, rare or no machines then, and no cash for a few days. Many businesses didn’t take cards, too. To write a cheque, a cheque guarantee card was required and they didn’t get young people very far. And if someone paid me by cheque, not only another wait on the queue but a further wait for clearing the funds. Instant payments were a dream. But there was a bank manager you could patiently wait for, often he listened (not many she), could give comfort, and perhaps offer sound, conservative, advice – if you had time. This book provides a balanced account of these shortfalls and benefits.
Banks and other providers of banking services of memory were also seen as more gentlemanly – because, well, they often didn’t compete. Price competition was thought unsavoury, viewed as potentially unsafe, by the banks and their regulator. Was this widely known? I doubt it. If you paid an extra one per cent interest rate on your 25-year mortgage, it is similar to paying 25% more for your house. Was everyone really OK with that? I wasn’t asked. Yet, there was comfort in the knowledge that if trouble arose you knew who to speak to – you just didn’t know how much that degree of service cost and no one, not the banks, really did. I am grateful for author Ian Peacock’s efforts to tell this story and explain how banking changed as competition and products evolved.
The first iPhone and its later banking apps coincided with fall of Northern Rock; banking apps and easy smart phone banking have become synonymous with the age of digital or remote banking (though we’ve had online banking since the 1998) and are blamed for the decline of the branch. This book tells the story of how the credit card in 1966 began the wave of credit decisions moving from branch to central office, from subjective and often personal decisions to computer approvals … that was 52 years ago. The digital transformation of banking has been remarkably slow moving by that measure.
This book provides a great service in reviewing a half century of banking, in detail, both good and bad. The author takes us through many of the devilish details: The consolidation of many inefficiencies in the system, such as very high cost protected specialist firms; The many culture clashes involved in merging those firms’ activities; and how regulators were involved well beyond what any law provided to their sudden loss of power and, finally, a massive increase in banking law and new regulators’ powers. The subject nearest to my career about banking is that of culture, in banks, in banking businesses, building it and destroying it. Not many years before the financial crisis, a then lauded bank chairman who didn’t come from banking publicly derided the conservativeness of his bankers and his bank’s governance when he hired a non-bank trained CEO. That bank became the biggest bank failure of all time – its leaders followed me to answering questions before the TSC and a shocked nation; this book puts that failure in context.
Our Brexit referendum process raised many questions and one of my favourite issues to arise out of the referendum concerned how our views of the past influenced our views of the future of our country; I take no sides here and note that multiple views of the past were expressed. However, I hope this book’s providing of greater clarification of banking past help us to better formulate banking future, based more on facts and important detail than nostalgia. I have wondered out-loud if our banking ring-fence regulation, which must be implemented next year, was about a nostalgic view of recreating a misunderstood past or about a better way forward. At a speech about ring-fence banking last year, a well-known economist told me that ring-fencing was about recreating a 1980s banking environment. I will leave readers to ponder the desirability of returning to the past as they read this valuable book.
Bankers currently are regarded as people out for themselves who are besotted with greed and who seem incapable of judging risk. Yet a few decades ago bankers were regarded as pillars of society, if somewhat boring; people who were unlikely to cause a stir. Anthony Sampson could write in 19621 ‘The puritan, nonconformist conscience of the early days still hangs over [the clearing banks].’ How have the banks and the bankers themselves changed over the period and how has society helped to mould those changes? Is there any way in which, in a modern, open, global society, bankers can redeem themselves and begin to act responsibly in providing and being seen to provide a useful public service? This account will attempt to answer these questions in the context of the UK, recognising that UK market developments have been profoundly influenced by events elsewhere.
The Situation in the 1950s and 1960s
The structure of banking in the 1950s and ‘60s was much as it had developed over a century earlier. At the apex was the Bank of England. The Bank exercised monetary policy using several different levers. According to the Radcliffe Report, published in 1959, the authorities had used the following measures to control the monetary aggregates: ‘… manipulation of short-term interest rates (but not of long ones); funding the floating debt, and so reducing the banks’ liquidity; official guidance – and eventually the fixing of a ceiling – on bank advances; the restriction of capital [market] issues … and hire-purchase regulations.’2 These tools could be mandatory, for example, the controls on hire-purchase lending, but more frequently they involved ‘persuasion’ by the Bank – known as Governor’s eyebrows. Bankers were expected to take note of the ‘mood music’ emanating from Threadneedle Street (the Bank’s Head Office). This included the Bank Rate, which although it had real effects, was also a highly symbolic figure. Professor Cairncross while questioning Lord Cobbold (Governor of the Bank) for the Radcliffe Committee in 1959 noted that ‘there is an old saying that prayers and incantations, with a little arsenic, will poison a flock of sheep. I wonder whether the Bank Rate plays the role of the incantations here.’ The Committee concluded that an increase in Bank Rate without other measures such as controlling public spending or hire-purchase terms would be – in the Governor’s phrase – like ‘spitting into the wind.’3
The Bank also had two other pivotal roles in the financial system – it was the principal bank of issue of banknotes and, increasingly during the nineteenth century, it acted as a regulator of the banks, particularly after the failure of Overend, Gurney and Company in 1866. As noted by Niall Ferguson,4 ‘Walter Bagehot, reformulated the Bank’s proper role in a crisis as the “lender of last resort” to lend freely, albeit at a penalty rate, to combat liquidity crises.’ For the last 150 years, banks have been unusual in that, unlike other types of commercial organisation, they could expect to be funded by a central authority if they ran out of cash.
Beneath the Bank, the most potentially powerful institutions were the clearing banks. Following rapid consolidation in the nineteenth century, clearing banking became highly concentrated amongst a very few names. By 1962, around 80% of all bank deposits were in the ‘Big Five’ banks: Barclays, Midland, Lloyds, Westminster and National Provincial (Westminster and National Provincial merged in 1968). These banks traditionally provided individuals and society with five principal services. Banks acted as channels for monetary transactions; retail suppliers of currency; trusted depositories for surplus funds; a mechanism for transforming (largely short term) deposits into (generally longer term) loans and a process whereby credit is allocated to those who are deemed worthy of receiving that credit.
These services are absolutely essential to the proper day to day running of an advanced economy. In 2015, the Greek authorities announced that banks would be closed for a week and that the availability of notes through ATMs would be limited. In fact, the banks were closed for three weeks. It is unlikely that much longer period of closure is compatible with the operation of commerce. Within a few days, people begin to hoard currency and banknotes become short. It becomes increasingly difficult to transact normal day to day transactions for food, fuel and clothing. And it becomes obvious that banks are utilities, in the sense that they perform a vital public service. This was recognised by the UK Government during the 2008 crisis and those banks seen to be in trouble were rapidly and publicly rescued.
By the nineteen sixties, the UK banking system was orderly, though hardly competitive. From 1939 until 1958, as Anthony Sampson points out5, the Treasury restricted overdrafts and the banks agreed amongst themselves not to compete for lending business. There were some glimmerings of competition – Midland Bank opened a branch on the Queen Mary – but broadly the clearing banks put stability and trust above competition and profits. Typically, banks kept 30%+ of their assets in liquid form6 and lent for comparatively short periods, often at call but usually only up to 5 years maximum. Contrast the banks in the lead up to the 2008 credit crisis when banks’ liquid assets went down to miniscule levels – well under 5% of their assets and they lent money for periods of 25 years and beyond.7
The banks also saw themselves as pillars of the social system, A colleague of mine, when he worked for Lloyds Bank, asked his manager for a mortgage (the servicing of which he could easily afford) for a detached house in Dorking. The manager refused on the grounds that it was a more expensive house than he, the manager, owned! More positively, bank managers saw themselves as trusted financial advisors to their customers. A letter to The Times provides a good example. Mr Broad (the writer of the letter) when young, some decades ago, had miscalculated his salary deposit and was called in by his Stourbridge bank manager. ‘Mr Broad, you were £ 2 in the red last month, and £ 4 in the red this month. I’m afraid you appear to be someone living above his income.’ (Letter to The Times June 15, 2015 from Ken Broad, quoting his Stourbridge bank manager’s reaction to Mr Broad’s ‘miscalculating a salary deposit’)
The archetypal banker could be as summed up by Anthony Sampson, ‘In their dedication, their lack of greed, and their sense of quiet service, the joint stock bankers (i.e. the clearing bankers) provide a placid, safe centre to financial Britain.’
In truth, the banks were bankers to just one part of British society. The banks themselves were stuffy and rather off-putting to those who were not used to them. Banks were mainly for the middle classes, while majority of working men and women put their savings either into the Post Office or into mutually owned building societies. On 31 March 19618 the deposits in the Post Office exceeded £ 6 billion, little different from the total deposits of the clearing banks. At the same date, deposits in those building societies which comprised the Building Societies Association were probably greater than those of the banks themselves9. The assets of these institutions differed from those of the banks. The Post Office was a mechanism for helping to fund the very large government debt which was a legacy of the Second World War. The building societies, as their name suggests, lent money to their members (who had usually been depositor members for a number of years) as mortgages for house purchase. At the time, the building societies had a virtual monopoly of the mortgage business, because banks were prohibited from mortgage business (apart from mortgages for members of staff). This may seem a strange restraint of trade but, given the problems banks later encountered when they were permitted to provide mortgage finance, perhaps there was some merit in it. It should be noted how risky the building society business model appeared to be. These organisations took short-term, often demand, deposits and lent the majority of them on mortgage for 30 years or sometimes longer. In principle, they appeared to be vulnerable to a run. Yet, there have been no significant defaults by building societies in which depositors have lost money (though there have been a number of ‘guided’ mergers). This has evidently been helped by the rise in residential property prices, but it was also helped by the ‘club’ atmosphere of the individual societies – they often drew members from particular localities or professions. Also, building society managers, who knew their borrowers well because they had usually been depositors for some time, were conservative people by inclination. As Sampson observes, ‘The building society knights are earnest, moral men, who have seen a movement become an institution in their lifetime.’10
Another type of financial institution used increasingly by all sections of the population was the hire purchase (HP) company. These had sprung up in the nineteenth century to finance purchases of semi capital goods such as sewing machines. They were already evident in the pre-war economy. The Spectator reported in 1939, ‘There seems to be no limit to the expansion of turnover which has been a feature of the history of the United Dominions Trust, the bank of which Mr J. Gibson Jarvie is chairman.’ (United Dominions Trust being the largest HP company.) Nevertheless, at this stage they were comparatively ‘small beer’. In the post-war society, customers became more reluctant to wait until they had saved enough to buy goods such as cars, televisions and refrigerators and the HP business grew accordingly. There were Acts of Parliament in 1938, 1954, 1957 and 1964 seeking to regulate this comparatively new market. By the late 1950s, HP debt was equivalent to around 30% of bank debt, and the HP business became impossible to ignore. Yet HP did not have a good name in some quarters. There was a view that people should save and only buy major goods with the fruits of that saving. Buying on the ‘never-never’ (as HP was known) was thought of as morally doubtful. These voices have not completely gone away as is evident from Joanne O’Connell’s comment in The Observer Saturday 25 August 2012. Una Farrell, for the CCCS (Consumer Credit Counselling Service), says: “Hire purchase deals can sound great, and for some people they work. But if you lose your job you could end up in a situation where an interest-free deal ends before you’ve made a single instalment. The message,’ she says, ‘is that it’s best to save up.’ Ms Farrell’s view was widespread in the 1950s and 1960s, particularly amongst more traditional bankers.
The institutions described above represented the vast majority of loans and deposits in the monetary system but there were other, often very influential, organisations which performed a range of specialised functions. For example, the Bank of England influenced interest rates by buying or selling bills of exchange and Treasury bills. In order to be ‘eligible’ for discount at the Bank, a bill of exchange had to be ‘accepted’ (i.e. guaranteed) by an organisation recognised by the Bank as an accepting house. These were the major merchant banks, numbering 17 organisations in 1962. The merchant banks carried out a number of other functions (including wholesale lending, money market and foreign exchange trading, bond issuance and dealing, equity issuance, corporate finance advice and investment management) but were named after their traditional bill accepting function. The merchant banks were not able to sell their accepted bills directly to the Bank of England. The bills were sold to a group of organisations called discount houses who in turn sold them to (or bought them from) the Bank.
None of the above entities dealt in equities. The merchant banks managed equity issues, i.e. flotations on the stock exchange and secondary market issues (i.e. issues of equity by quoted companies) and arranged underwriting for those issues. But the merchant banks neither sold equities to retail or wholesale buyers – this was the job of the stockbrokers – or traded in equities – the preserve of the stockjobbers. The merchant banks regarded themselves as superior to the brokers and jobbers (though there were also hierarchies within the broking and jobbing communities). In the mid-eighties, just before Big Bang, I was interviewing a merchant banker about the possibility of the merchant bank merging with a broker and a jobber (the law was about to change enabling such mergers to take place). He was against such mergers because ‘broking was an insanitary business’. Such extreme views were rare but the feeling of a hierarchy of institutions definitely was not.
The highly specialised and formal institutional style had both advantages and disadvantages. Organisations tended to take notice of regulators’ wishes, even when they did not have the force of law. For many years, the clearing banks agreed on a ‘self-denying ordinance’ under which they undertook not to compete with each other in the loans market.11 I once fielded a call from the Bank of England (in the 1980s) requesting that we reduce the amount of a certain money market transaction on our books. The transaction was neither illegal nor ethically doubtful and we were breaking no regulatory rules, but it was having the effect of inflating the money supply, an indicator which the Bank then regarded as vital. We, of course, obeyed without question; the Bank had made its feelings known, so there was no alternative. Other organisations, such as the Takeover Panel, also usually operated by suasion rather than the force of law.
This behaviour towards regulators was part of a general concept of reasonableness. People worked hard in some areas of the City (not in others) and were generally paid well or very well, but not outrageously, for their efforts12. There was a feeling, whether justified or not, that fees, commissions, etc., while high, were not egregiously so.
A major problem with this cosy market was that many of the fees charged were essentially determined by cartel arrangements. For example, the accepting houses (the major merchant banks) used to earn a minimum of 1% p.a. when accepting (i.e. guaranteeing) short-term bills of exchange for blue chip borrowers. When British Petroleum broke this barrier and raised money at 7/8% p.a., the merchant banks were worried that their orderly world was threatened. These cartels did not of course encourage innovation, or excellence of any kind. ‘In the 1950s and 1960s the British financial system was riddled with cartel arrangements, artificial distinctions and barriers’13. By the late fifties/early sixties there was pressure, both from within government and from the City itself, for some reform to take place.