A loophole in the Government’s planned bank reforms risks leaving the taxpayer on the hook for billions of pounds in the next financial crisis, the Governor of the Bank of England has warned.
Sir Mervyn King said protection for depositors whose savings temporarily rise above the £85,000 compensation limit was needed or the Chancellor will come under “enormous pressure” to resort to a state bail-out again.
Paul Tucker, the Bank’s deputy governor and favourite to take over from Sir Mervyn next year, said it was “a huge issue” that had yet to be resolved. “The best laid plans [could] get blown up,” he told the Parliamentary Commission on Banking Standards, where he also clashed with the Governor over issues of bank reform.
Under new arrangements to spare taxpayers another costly bail-out, bondholders will be forced to take deep losses if a bank is on the brink of collapse. However, depositors would suffer equivalent losses on anything above £85,000 as they rank alongside bondholders.
“For any big bank on any given day, there will be thousands of people who through no fault of their own happen to have deposits in their bank of more than £85,000,” Sir Mervyn said. “There will be people who are going through a house purchase, who have received inheritance, others with a divorce settlement who are just keeping it for a couple of weeks.”
In the event, the Chancellor would have to decide to trigger a bank resolution plan that could potentially cost people the bulk of their life’s savings. “If you have thousands of people involved, I think the pressure on the Chancellor will be enormous,” he said. Mr Tucker acknowledged that issue could make a private sector resolution "politically unpalatable".
The risks are acute in the UK because the vast majority of deposits are held by just five institutions. If the Chancellor caved in and provided a blanket depositor guarantee to protect the “thousands” who had innocently breached the limit, the decision would automatically rescue bondholders.
As a result, like in 2008, private creditors would escape and taxpayers would be left picking up the bill for a bail-out.
Lord Turnbull, a member of the PCBS, said: “We must not set up a system which says it is going to work in this fashion, when it doesn’t actually reflect the realities of what’s going to happen.”
The issue was first raised about three years ago but has not been tackled, Sir Mervyn said. The commission heard and proposed a number of ideas, from a trust account to separate insurance arrangements.
The commission also saw Sir Mervyn and Mr Tucker clash over a number of issues of bank reform. Sir Mervyn said he wanted full separation of retail and investment banks but, asked whether he agreed, Mr Tucker said: “Not completely.”
He also disagreed with the Governor and Andy Haldane, executive director of markets, over where to place the ringfence that will protect high street retail banking from risky investment banking under the Vickers proposals. Unlike Sir Mervyn and Mr Haldane, who suggested that small business lending should be exclusively inside the ringfence, Mr Tucker was happy for it be outside as well.
Sir Mervyn also called for greater legal clarity on where the ring-fence should fall. “We haven’t got to the clarity required,” he said. “It would be wrong to leave it purely to the discretion of the regulator, because that would increase the pressure of lobbying of banks directly on the regulator and indirectly on the government and parliamentarians.”
However, he said the reforms need to be implemented: “I really don’t want the last five years to go to waste by kicking [the] Vickers [reforms] into the long grass... I will feel deeply disappointed if the outcome of this debate is we don’t implement Vickers now.”
He suggested reviewing the ring fence in “three, four or five years” to see whether it was working and whether full separation was the better solution.