What's The Problem With The Banks?

The Financial Crisis

The financial crisis which rocked the world in 2008 started in the financial sector, but quickly moved from there into the real economy. It caused a great recession which governments continue to try fight off, getting highly indebted in the process. In the UK, the government is now trying to reign back spending to reduce its deficit, created whilst saving the economy during the financial crisis. This is leading to major cuts programmes in the public sector, which means the fact that nurses are currently losing their jobs is directly linked to the risky activities of bankers and traders in the pre-crisis bubble.

It's true that there were many factors in the financial crisis, but when push comes to shove, it all originated in the risky activities of banks. So how did they create the bubble? It started with commercial banks lending vast amounts to fund residential and commercial property mortgages. Investment banks then took those loans off their hands, packaged them up into investment products and sold them off to others, like pension funds, to buy as investments. The idea was to lend as many mortgages as possible, regardless of the risk, and then quickly flip them on like hot potatoes to the next person before they blew up.

The whole process was reminiscent of a giant ponzi scheme, and it was only a matter of time before it all came crashing down. And when it did, we all felt the consequences. The banks felt the consequences too, but only mildly. They were bailed out by the government, and the traders who created the products didn't lose their enormous bonuses that they had earned in the process. It's all very well saying you're sorry for causing a giant recession, but it just doesn't seem that plausible when you're saying it from a penthouse suite in the Ritz.

And that's how it stands. The greatest heist in history was pulled off, and, give or take a couple of casualities, the financial sector is pretty much still raking in the cash. It's smaller taxpayers and smaller businesses in the real economy that have had to foot the bill and take the hit.

Apparently the banking sector is full of highly intelligent people, but the sum total of that intelligence seems to be little more than a giant rip-off at the expense of others. It's time we said 'thanks guys, for nothing', and moved our money to smaller, more honest, players.

Risky Speculation

Banks decide where new money is injected into the economy. We need banks that direct credit towards small and medium-sized businesses, the engines of growth in any economy, rather than banks that funnel money into unproductive and destabilising speculation.

Speculation is a process of short-term betting on assets, rather than long-term investment. In the years preceding the ongoing financial crisis, for example, banks directed floods of new money into mortgages and commercial property loans, which investment banks turned into 'securitised products', leading to huge housing bubbles and eventual financial collapse.

Now that the housing bubble has collapsed, banks continue to facilitate other forms of damaging and risky speculation. Take for example 'food speculation', the process of betting on the price of basic food. Over the last few years campaign groups such as Oxfam, World Development Movement, and Christian Aid have raised serious concerns about this practice, as have UN bodies such as UNCTAD. Former broker Brett Scott discusses this with us:

"Food speculation is the process whereby speculators bet on the price of food by using commodity derivatives. Major banks are key players in this game. Barclay's Capital (the investment banking arm of Barclays) for example, is one of the world's largest dealers in derivatives based on food staples like wheat and corn. Banks act as middlemen in arranging these bets, and they also lend money to short-term speculators like hedge funds to gamble in these markets. More recently they have encouraged bigger investors like pension funds to put money (your money for your pensions) into commodity investment products that they have created.

The sheer weight of money flowing from these financial players into agricultural markets has the potential to create major food price bubbles which cause extreme hardship in countries where food costs make up a large part of household income. Furthermore, when the level of speculation in a market gets too high, markets become highly volatile, with fast-moving money flows exacerbating upward and downward swings in prices. That makes it more expensive for real producers and consumers of commodities to protect themselves from price fluctuations, and makes life more unstable for all.

Banks and other financial players argue that there is no such thing as excessive speculation. They argue that regulators and concerned organisations don't understand the technicalities of these markets and should thus stop fussing. But wait, isn't that the exact same thing they said before the financial crisis?"

The World Development Movement has been spearheading a campaign against Food Speculation, focusing on the role of Barclays in particular. For more information on this serious issue, visit their campaign page

Starving Small Businesses

The UK banking system has spent too much time lending to unproductive speculation and large FTSE 100 companies, instead of nurturing the small and medium sized enterprises (SMEs) that really drive a vibrant economy. This is short-sighted because the health of the large corporates depends crucially on the health and dynamism of all our small enterprises.

Despite government encouragement through schemes such as "Project Merlin" (under which banks are supposed to hit targets for investment in small businesses), the major banks in the UK show few signs of being prepared to invest in the future economic health of the country. David Boyle, fellow of the New Economics Foundation and author of The Human Element: Ten new rules to kickstart our failing organizations' discusses the problem for us:

"'Credit Easing', the latest Treasury scheme to encourage UK banks to lend to small businesses, marks a belated recognition that UK banks are no longer geared up to lend to those that really drive employment and growth. It is however, very unlikely to solve the problem. The fact of the matter is that large banks are not fit for the key purpose we need them to fulfil.

The UK banking sector is monopolistic, highly centralised and ineffective. There are big banks in the USA, France, Germany and Switzerland, but those countries also have something which we don't: A highly decentralised and stable mutual lending and local banking network which does the job for the economy

The UK has 190 bank branches per million inhabitants (including building societies). This compares with over 470 and 940 branches per million inhabitants respectively in Germany and Spain. When it comes to lending money to small businesses, you need local bankers who know the area and can exercise judgement.

There are still those in government who argue that this doesn't matter, and that the economy will be brought out of stagnation by big business deciding to open its wallets. But why should the UK economy be forced to struggle along with one hand tied behind its back, waiting for big business to act? We need to boost the myriad of energetic and enthusiastic small players.

All we can do, as individuals, apart from urging the government to act, is to put our money somewhere where it can be used effectively – and not where it will be speculated with and used to support the outsized bonuses of the big bankers."

Unethical Investments

Over the last several decades mainstream banks have had few qualms about lending money to dictators, weapons manufacturers, companies with poor human rights records, and companies involved in environmental destruction. When accidents happen, or when a negative story leaks out, banks have made a show of being concerned, signing occasional agreements such as the Equator Principles. Nevertheless, with little oversight in many developing countries, banks consistently slip back into financing lucrative but unethical enterprises.

Take for example human rights. Some of the worst human rights abuses in the world are perpetrated by governments against their own people. Sadly, mainstream banks generally see this as somebody else's problem and continue to fund oppression by lending directly to dubious governments, and by providing banking services to corrupt elites. We asked Anthea Lawson from rights group Global Witness to give us the lowdown on banks' involvement with dodgy regimes:

"In the last few years people have rightly become concerned about the damage inflicted by banks on the UK's economy. Less well known is the havoc that banks have been inflicting on the economies of developing countries for decades.

Many 'poor' countries, especially in Africa, are rich in natural resources. Yet their people continue to live in poverty and depend on aid. Why? Because their rulers corruptly keep the natural resource profits for themselves.

But corruption is just what happens in Africa, right?

Wrong. Corruption cannot happen without a bank. You can't keep millions – or billions – of stolen oil dollars under the bed. For a start, it wouldn't fit. But more importantly, you need a bank to stash it in.

Money paid by international oil and mining companies for natural resources is not paid in cash. It is paid by bank transfer. It needs a bank to transfer the money into a private account – and another to accept it into that private account.

Corrupt politicians can then pay for fixing an election, pay off political cronies, build up their armies, buy houses in London or Paris, or go on a shopping spree for fast cars and luxury yachts.

Laws are in place requiring banks to check out their customers and make sure their money is all above board (that's why you need a passport and utility bill to open an account these days). Banks must do extra checks on customers who are politicians of other countries and make sure they are not accepting stolen funds from them.

But our banks keep on doing business with corrupt rulers. To make matters worse, our own regulator (the Financial Services Authority - FSA) is doing little to stop them. It acknowledged recently that three quarters of UK banks were not doing enough to identify the source of funds of foreign politicians, but has failed to name them – hardly a deterrent.

Global Witness found that HSBC, Barclays, RBS, Natwest and UBS had accepted millions of pounds of corrupt money from two Nigerian state governors. Nigeria earns billions from oil yet millions of its people remain in poverty. Half the population lack access to fresh water. By accepting corrupt funds the banks are helping to perpetuate the problems faced by countries like Nigeria.

It should be as unacceptable for a bank to take stolen money and prop up dictatorial regimes as it is for BP to pollute the Gulf of Mexico. Customers of these banks can help this to happen, by voting with their feet.

Further examples of banks accepting money from corrupt politicians are available at www.globalwitness.org/campaigns/banks."

Banks also continue to fund environmentally destructive projects, feigning ignorance about their role in supporting pollution, soil degradation, climate change, extinctions, and disruption of indigenous peoples' livelihoods. Tim Hunt from the Ethical Consumer gave us a frank assessment of banks' approach to the environment upon which we depend:

"The UK's biggest banks continue to avoid taking their environmental responsibilities seriously. From tar sands investments to the funding of coal mining and aviation projects, it seems no investment is off limits - whatever the environmental consequences. The banks often pay lip-service to environmentally responsible lending, through membership of groups such as the UNEP Finance Initiative, and through paper-thin policies and PR spin. But the reality is a long way from the rhetoric.

While the big banks have environmental reporting in place, this is often weak and fails to take into account the full extent of the investments made and the relationships they have with environmentally damaging projects. For example, Barclays might have an "Environmental and Social Impact Assessment (ESIA) policy" but it has not stopped investment in destructive tar sands.

RBS is the same. Despite some environmental commitments, it is in fact extending its investment in unconventional fossil fuels, recently helping to fund tar sands projects in ecologically fragile Madagascar. Barclays, along with RBS and HSBC is currently subject to a boycott call from Ethical Consumer for their significant involvement in financing tar sands development in Canada.

Barclays, RBS and HSBC have also recently been singled out by the Ecologist for involvement in some of the world's most environmentally damaging projects, including mega coal fire power stations and open-pit gold mining. Barclays, RBS, and HSBC all make it into the list of top 20 'Climate Killer' banks for their involvement in funding the coal industry in particular."

Abusing Government Support - Putting an end to bankers' private welfare state

High street 'retail banking' for individuals should be a stable and predictable business. People should be able to deposit money which they earn fair interest on, and to borrow money which they pay fair interest on. A well-run retail bank should have trustworthy and stable managers developing relationships of trust with depositors and borrowers.

When you deposit money into a major bank though, you may be supporting an institution that is simply too big for its own good. You might not realise it, but many big banks have focused all their efforts on building huge investment banking operations. Barclays PLC, for example, makes the majority of its revenues from its investment bank, called Barclays Capital ('BarCap'). Unlike retail banking, investment banking is often very risky and has a much more flashy culture. They borrow lots of money to put on trades that are often highly lucrative, but that can also go wrong very quickly.

This poses serious potential problems for normal banking customers like us. For example, what would happen if Barclay's Capital took a bit too much risk and got in serious trouble? We asked former investment banker Lydia Prieg from the New Economics Foundation to explain some of these key problems:

"The major UK banks, including the Barclays Group, are considered to be 'too-big-to-fail'. There's an implicit assumption that if they got into trouble, the government would step in and bail them out, even if the problem was caused by reckless speculation.

This has happened before with banks during the financial crisis. The bail-outs and guarantee schemes extended to the banks as of Dec 2010 were estimated to be worth approximately £500 billion.

This is just one of many ways in which taxpayers currently subsidise the banks. For example, as a result of the implicit taxpayer guarantee, large banks are able to borrow at lower interest rates than they would be able to if they operated in a truly free market. These artificially low interest rates brought the four biggest UK banks (Barclays, RBS, Lloyds, HSBC) a combined subsidy of £45 billion in 2010.

The government's plans to 'ring-fence' retail banking away from investment banking (by 2019) will reduce but not eliminate the subsidy – we will still have banks that are simply too big for our economy.

In addition to unfairly inflating the big banks' profits, this 'too-big-to-fail' subsidy gives large banks a huge commercial advantage over their smaller counterparts and new banks trying to enter the market, and so helps suppress competition, which, of course, hurts consumers.

Even more crucially, whilst a sense that the government would intervene exists, risks will not be fully borne by the risk-takers. This means traders and bankers will be encouraged to take excessive risks at your expense, and at the expense of all other ordinary taxpayers, bringing continued instability into the financial system.

It is time to bring an end to the bankers' private welfare state."

Bonuses - What's that you say Mr. Diamond? You only got paid £9 million last year?

Ever get that feeling that bank bosses act sorry in public and then snicker at us behind closed doors? That might be because, no matter how sorry they might be, they go home with enormous piles of cash. For many people, that doesn't seem right, especially considering the banks only survived due to direct or indirect taxpayer support.

The figures for annual bankers' bonuses speak for themselves. Total UK based bonus payments are expected to amount to more than £6 billion this year - roughly the same amount as the total public sector spending cuts package being implemented by the government.

Senior bankers argue that high pay is a reward for high performance, and that the prospect of huge rewards motivates individuals to work hard. Yet, that line seems hard to swallow when we consider the real damage the financial sector has wreaked on the real economy over the last few years. Bankers' belief in their inalienable right to a six figure bonus is becoming increasingly out of step with their just deserts. We asked Zoe Gannon from the High Pay Commission to fill us in:

"While in most businesses top pay refers to that awarded to boardroom executives, in banks it is very often the case that the highest earners are below board level. In Barclays, the top five non-board executives have been awarded a combined total of £49 million in salary, bonuses and long-term incentive plans in 2010. The top-paid banker will receive £14 million, 1,128 times the amount taken home by the lowest-paid member of staff.

Lloyds reveals that up to nine of its employees earned more than the £3.4 million paid to CEO Eric Daniels. And HSBC revealed that its highest-paid banker was paid more than £8.4 million. The financial regulator, the FSA, says that more than 2,800 bank staff received more than £1 million in 2009 across 27 banks.

The public anger over bank bonuses has not significantly affected total pay in the sector. In 11 European banks staff costs last year totalled $164.5 billion, up 7% from 2009. In response to public criticism, some banks have moved their bonuses underground by ensuring a greater proportion of pay is awarded through basic salaries, and bankers across the globe are now getting a higher level of fixed pay. HSBC, for example, reduced levels of bonuses but doubled basic salaries."

It seems increasingly clear that regardless of public opinion the only factor that can affect bonus awards in the banking sector is profitability. Bankers seem to forget though, that profitability over the last few years is directly linked to taxpayer-funded support and bailouts.

Tax Avoidance

With their risky speculation, unethical lending, and huge bonuses underwritten by government bailouts and guarantees, you'd think major banks would at least feel obliged to pay their rightful taxes. In reality, banks are masters at tax avoidance, and often blatantly so. In this section, renowned tax commentator Richard Murphy of the Tax Justice Network explains the situation:

"Big banks avoid tax. That's a matter of fact. They go out of their way to do so, and help other huge companies do so as well. And they succeed: Tax Research has monitored their effective tax rates for over a decade and has concluded that we have lost billions of pounds of potential tax revenue over this period due to tax avoidance.

From 2000 to 2009 the biggest four banks paid well under the expected tax rate of 30%, with tax rates averaging instead in the low 20s. In 2011 Barclays paid only £113 million on their record profits, leaving a shortfall of £3.1 billion. See my report for further details on this serious issue.

But how have banks done this?

Firstly, they exploit the UK's tax rules to the limit. This is one of the things that units like Barclays Capital do when they supply what is called 'structured finance'. Most of this is built around what they call 'tax efficiency', otherwise known as 'playing the loopholes'. It may be legal, but it's a long, long way from being acceptable to most ordinary people.

Second, they exploit tax havens. In my 2008 survey of how many tax haven subsidiaries banks have, Barclays had 143 subsidiaries in the Cayman Islands, Lloyds had 60 in Jersey, HSBC had 24 in Panama and RBS had 10 in Luxembourg (See this table for further details). You cannot explain the vast majority of these subsidiaries unless they were set up for tax avoidance, either for themselves or for clients.

Thirdly, they use complexity. By having hundreds of subsidiaries in tax havens (over 1,200 in all between Lloyds, Barclays, HSBC and RBS in 2008) banks leave a trail of confusion in their wake, making their tax affairs very hard to assess. That might help explain why the recent Parliamentary Accounts Committee report suggested there may be £25 billion of tax disputed in the UK right now – tax that should be resolved and paid.

Big banks think such activity pays. It's time that the people of this country, who are losing out as a result of this tax avoidance, show them that it doesn't by moving their money."

Mis-Selling

It seems that every few months a new 'mis-selling' scandal emerges in the banking sector. Mis-selling is a fraudulent activity where bank salespeople deliberately sell financial products to people without fully informing them of the risks involved. Financial products can be complicated, and it's easy for people to be confused and mis-led. HSBC, for example, was recently fined for selling products to elderly people in the full knowledge that the people were getting a really bad deal. It said it was 'profoundly sorry', but not as sorry as all the people who got shafted in the process. Consumer advocate, and Secretary General of Cooperatives UK, Ed Mayo, has this to say:

"A major reason why banking is in crisis is because high street banks operate in the interests of their shareholders, not their customers.

Banks can play a helpful role in the economy, providing a place for our savings and a source of finance for those who can put it to good use. A good bank is one that treats its savers and its borrowers fairly and offers each a competitive rate.

When banks are owned by shareholders though, there is always pressure to put the interests of outside investors first, using depositors' money in more risky ways than they should or selling products that profit the bank at the expense of customers.

This is not new. It is the reason why we have had banking regulation for hundreds of years.

But over the last thirty years, banks have campaigned vigorously to cut back regulation and created new financial products and accounting devices that sidestep regulators.

As a result, we have two scandals that stem directly from the way that banks are owned and run. First, the failed loans packaged and sold between banks that brought on the credit crunch. Second, the ongoing tally of mis-selling to consumers which takes advantage of the fact that, compared to buying a toaster or even a car, it can be hard to judge the value of a complex financial product.

There has been a drip, drip, drip of financial scandals from banks. Even ignoring the financial crisis and bank bail-out, the best estimate we have of the total cost to UK consumers over the last five years of mis-selling alone (from personal pensions and payment protection insurance through to punitive charges on current accounts and overdrafts) is £32 billion - money which has gone straight from ordinary customers to banks' executives and shareholders.

If you have your money in a shareholder-owned bank, you are always at risk of being part of the problem. Your money has been used in the recent past in a wholly destructive way and it will be again. If you have your current account or savings with a co-operative or mutual bank or credit union, your money is much more likely to be used for good and you are part of the solution."