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Are British banks getting billions in hidden subsidies? 14.02.11

A new briefing from think-tank nef (the new economics foundation), released the day before Barclays announce their full year results.’ Feather-bedding Financial Services’ briefing asks whether banks would be making any profit at all without billions in hidden subsidies from the British taxpayer and bank customers.



The nef briefing, Feather-bedding financial services, ask, in addition to the unprecedented public support for the financial sector over the past three years, how much are the big banks benefitting from hidden subsidies?

To begin to answer that question, analysts at nef drew together research from the Bank of England, the Office of Fair Trading, the Institutional Investors Council and Moneyfacts. From the limited information in the public domain, analysts were able to identify a range of hidden subsidies that dwarf the Chancellor of the Exchequer, George Osborne’s recently announced bank levy. nef’s analysts believe that what they were able to identify may prove be just the tip of the iceberg.

“It is almost inconceivable given the existing scale of public financial support to the banking system that there might be further hidden subsidies. However, the apparent return to profitability for which large bonuses are still being paid is deeply questioned by our research which reveals another layer of publicly-funded feather-bedding for financial services. A new rule book needs to be written based upon a full transparent account of the banks reliance on the British taxpayer and a new deal struck to end the culture in which for the banks it is always heads they win, tails they win.” says Andrew Simms, nef fellow and co-author of the briefing.

“The unique nature of banking requires that the system is backed by the state. This combined with a lack of real market competition to effectively hand the banks tens of billions in subsidies from customers and taxpayers. The long-term success of the City depends on efficient and cost-competitive investment banking services for investors and corporate clients, and the UK’s prosperity depends on banks that can stand profitably on their own without having to exploit taxpayers and customers,” says Tony Greenham, head of banking and finance at nef and co-author of the briefing.

Increased scrutiny of the financial system in the wake of the banking crisis has shed light on a number of practices previously taken for granted, which must now be viewed differently. The sheer complexity of modern banking (itself one of the conditions which brought on the global financial crisis) has acted to sheild the sector from difficult questions. But, with the dust of public interventions now settling, a number of anomalies are emerging. Feather-bedding financial services, identifies at least three significant hidden subsidies:

- The ‘Too Big to Fail’ subsidy: The government now provides a public guarantee, effectively insurance against banks going bust. This gives banks a huge commercial advantage over other firms in a market system. It means banks are able to borrow money much more cheaply than if they were not ultimately underwritten by the public. Exchanges with leading auditors in front of the House of Lords Select Committee on Economic Affairs in January 2011 confirm this. A conservative analysis reveals that this hidden subsidy could be worth £30 billion annually. It means that bonuses to senior staff for ‘performance’ and dividends to institutional investors are at least in part a straight transfer from the taxpayer.

- The quantitative easing windfall subsidy: When it was decided that the economy needed more liquidity, the Bank of England pumped money in using the technique called ‘quantitative easing’. To meet various, and sometimes self-imposed, requirements, it did by purchasing government bonds through investment banks. Merely for being passive conduits for this ‘risk free’ arrangement the banks took a cut of every trade. Here nef analysts found that banks enjoyed a significant windfall, but that lack of transparency keeps the likely amount hidden.

- The ‘make the customer pay’ subsidy: Looked at sympathetically, the banks have been put in a difficult position. At the same time as being required to rebuild their capital, they are also under pressure to lend. In response, the banks have tried to manage this by increasing the gap between what they have to pay to borrow money, and what they charge people to borrow from them. This is the so-called interest rate ‘spread’. But the banks have a choice. They could recapitalise by reducing or eliminating bonus and dividend payments until their capital base is rebuilt. As it is, the taxpayer is subsidising the banks twice over: once through taxpayer funded public support to the banks, and secondly through paying much higher interest to borrow than the banks do. This hidden subsidy to retail banking and one part of the investment banking world amounts to at least another £2.5 billion each year.

The briefing concludes that these hidden subsidies must be investigated further and that if the Independent Commission on Banking is to properly do its job, it must establish a full picture of the de facto hidden subsidies being enjoyed by the banks.

Download Feather-bedding Financial Services briefing

Peter Shield

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