Why banks must be allowed to die
There's something of an Old Testament sermon at the kernel of the latest Financial Stability Report by the Bank of England.
When discussing how to reconstruct the banking system so that its periodic excesses never again propel more-or-less the whole world into recession, this is what those sobre chaps in Threadneedle Street say:
"To control risk-taking, financial institutions need to face a credible threat of closure or wind down."
Or to put it another way, the prospect of death rather focusses the mind. For most of us, it's a deterrent against taking excessive risks.
If we knew that we'd always be patched up and kept alive, no matter how much damage we wreaked on ourselves through reckless behaviour - well, we might be tempted to party just a little bit harder than is wise.
So banks too can't be expected to behave themselves unless and until they become convinced that the deal-too-far would send them to the knacker's yard, rather than landing taxpayers with an enormous bill for rescuing them.
Which implies three things:
(1) Banks must be prevented from pumping themselves up to such terrifyingly enormous dimensions as became almost commonplace. Because no government would ever willingly take the risk of allowing the precipitous demise of a bank, like Royal Bank of Scotland, the assets and liabilities of which exceed the output of the British economy by a comfortable margin. If RBS had gone bust, the UK would have been hammering on the door of the IMF for succour.
(2) No bank should be so complex that the relevant regulator can't confidently predict the impact on other financial institutions and the economy of its demise.
(3) All banks should write a contingency plan - what Mervyn King calls a "will" - that would make it easy to protect and separate the deposits of its innocent retail customers, in the event of an accident that mullered the shareholders and other creditors.
Those are the three rules for sanitising the banking system. Sounds simple enough, doesn't it?
If only it were.
The financial elite is broadly divided into three groups on all of this:
(a) there's the Treasury and the Financial Services Authority, which believe that banks can be encouraged to go on an crash diet by imposing a hefty punitive tariff - in the form of disproportionately high capital ratios - on those that remain dangerously big and complex;
(b) there's the Lib Dems, the Tories and (not quite yet) the Bank of England, which explicitly or implicitly say that banks have to be bifurcated by fiat;
(c) and then there are the grey-haired bankers, who think that chaps like me will soon tire of our tedious preoccupation with their size and structure, and they will soon again be gorging to their hearts' content.