City of the future

28 Oct 2013 By Hugo Dixon

Finance has rightly been in the sin bin for the last six years. And the cleanup job isn’t finished. But Mark Carney, the new Bank of England governor, is correct to stress how a large and expanding City of London is good for Britain, Europe and the world – provided it is properly organised.

Carney’s comments, in a speech last week, will seem heretical to many – maybe even to his predecessor, Mervyn King, who showed a barely disguised disdain for financiers. Would it really be healthy, for example, for the balance sheets of British banks to reach nine times GDP, double the current ratio – as Carney projected they could by 2050?

British public will have some big questions about the potential resurgence of finance. Will taxpayers be asked to swoop in again to bail out bust banks? If a rescue is needed, would the government have the wherewithal to support a gigantic sector? Is it wise for the UK to put so many of its eggs in the finance basket?

The answer to the first question is not yet a firm “no”. The job of making the financial system safe is still a work in progress. The priority is to ensure that any bank can fail without wreaking economic havoc. In theory, this can be done by “bailing in” shareholders and bondholders, rather than relying on taxpayers. But there must be enough capital to absorb all the losses and authorities across the world will have work together seamlessly.

Carney is alive to this issue, and in a position to do something about it. He’s not just governor of the Bank of England. He’s also chair of the Financial Stability Board, the body tasked by the G20 to fix the global financial system. But until more progress is made, the public cannot relax.

Quite apart from the macro risk posed by finance, there’s also a question of culture. Too many financiers see their task simply as making as much money as possible for themselves, rather than serving the economy. The crackdowns on excessive compensation and penalties for bad behaviour – such as JPMorgan’s provisional $13 billion settlement for a range of malpractices including mis-selling mortgage-backed securities during the bubble years – are changing culture a bit. But there is further to go.

Even so, the City should not wait for perfection before getting back onto the front foot. For centuries, finance has been a central part of the UK’s economy. It currently contributes 13 percent of GDP, when related professional services such as law and accountancy are included. And the British are world leaders.

Of course, it would be good for Britain to build up its comparative advantage in the creative industries, pharmaceuticals, education and other services where it has a comparative advantage. But there’s no sense in artificially hamstringing the City – provided, again, it is properly regulated.

The opportunities for the City over the next few decades are considerable. And most of them won’t involve larger balance sheets at British banks, or even at the London operations of foreign banks. The biggest areas of growth will be in “markets-based” finance – in which banks will still be involved, albeit not as lenders.

Carney made a few seemingly heretical points about markets-based finance too. He said it was important to rebuild “securitisation”, the process of packaging up loans and selling them onto investors. He also said he wanted to turn “shadow banking”, effectively lending that takes place outside the formal banking system, into “transparent, market-based finance”.

Securitisation and shadow banking are dirty words for some people, after the role they played in the credit crunch. But transparent and robust markets are, in many ways, a healthier form of finance than banks. Carney pointed out, for example, how the equity markets, which meet this description, didn’t seize up in the crisis.

The City’s future is mainly in markets rather than straightforward banking. What’s more, in this, it has the chance to be the world’s leading centre. In recent years, it has become a hub for emerging market activity. It is now focusing on how to help Chinese finance open up to the world.

But the City’s biggest opportunity is closer to home: its EU hinterland. This is because the EU’s “bankcentricity” has been a source of weakness. The single currency zone would be more resilient if its financial system was more markets-based, like America’s. As Carney put it: “There is a strong case for greater reliance on robust financial markets relative to weakened banks.” Such a shift would benefit Britain as much of the business would flow through the City.

This opportunity won’t materialise fully if the EU continues to be suspicious of markets and presses ahead with plans such as a financial transactions tax. But the way to change minds is to engage with those with whom you disagree.

Here again, Carney can offer a new approach. Mervyn King often gave the impression that he was bored with European meetings and secretly hoped the euro would collapse. Carney, by contrast, has gone on a charm offensive. His first phone call was to Mario Draghi, European Central Bank president, and one of his first meetings was with Michel Barnier, the European Commission official responsible for financial regulation.

Much more needs to be done to ensure the UK can host a large and growing financial sector that is also safe. But Carney has started to point the way.


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