By bizn_fun 
Back-slapping bankers will be thick on the ground in the Swiss ski resort of Davos this week, as Rachel Reeves flies in to mix with the global elite. But she might be wise to treat the finance bros with a certain froideur.
That has not been Labour’s approach thus far: Reeves spared the banks from a windfall tax in her 26 November budget, and the UK’s regulators have just loosened capital rules, for the first time since the financial crisis.
Back in the summer, bank share prices ticked down after the Labour-leaning Institute for Public Policy Research (IPPR) recommended an £8bn levy on the windfall profits made as a result of quantitative easing (QE).
Insiders at other thinktanks said at the time it was made clear to them by the Treasury that publishing such forthright policy proposals was not a welcome contribution to the debate. When it came to budget day, the banks were left untouched.
JP Morgan responded with the announcement of a new £3bn HQ in Canary Wharf, east London, with chief executive Jamie Dimon saying the “UK government’s priority of economic growth has been a critical factor in helping us make this decision”.
His praise came as little surprise, as the FT had already reported that Reeves’s team, lobbied heavily by the banks against a windfall tax, had been urging financial executives to show their gratitude for the chancellor’s forbearance.
Little more than a week later, the Bank of England announced it would reduce banks’ capital requirements – the reserves they must hold against their assets to absorb potential losses.
The logic for both decisions was clear: the financial sector is, as Reeves told City bigwigs in her first Mansion House speech, the “crown jewel” of the economy, and with growth puttering along just above zero, now is not the time to plunder the banks for tax revenue.
Moreover, the argument goes, lowering capital requirements will free up more lending capacity so that banks can support productive economic activity.
As the Bank’s financial policy committee (FPC), which sets the benchmark for reserves, put it: “Banks should have greater certainty and confidence in using their capital resources to lend to UK households and businesses.” The move followed Reeves urging all regulators to act to bolster growth.
Except … there is a catch. As contributors to a timely conference at the London School of Economics (LSE) made clear last week, once a country’s financial industry reaches a certain size – which the UK’s sector has long surpassed – it stops boosting growth and starts to become a brake; a result reinforced in a string of academic papers spread over more than a decade.
Alex Cobham, chief executive of the Tax Justice Network, was one of the conveners of the appropriately named Too Much Finance conference. “We seem to be in a generation in which our politicians are trapped in the view that finance is one of the great things that the UK has to offer, and we really need to protect it and grow it,” he said.
“Actually, the research really consistently shows that the UK is far past the point where we would maximise the benefits of finance. And actually, it’s a drag on the economy, and has been for a long time.”
That’s partly because having a disproportionately large finance sector leaves the UK more prone to finance-driven crises, as Reeves’s Labour predecessors Gordon Brown and Alistair Darling learned the hard way in 2008.
But it’s also about what it means for how the UK’s economic resources are deployed. As one landmark academic paper, by Stephen Cecchetti and Enisse Kharroubi of the Bank for International Settlements, put it back in 2012: “Finance literally bids rocket scientists away from the satellite industry. The result is that people who might have become scientists, who in another age dreamed of curing cancer or flying to Mars, today dream of becoming hedge fund managers.”
Or as Adair Turner, then chair of the then Financial Services Authority, pithily put it in 2009, when the memory of the financial crisis was still fresh, much of the activity that goes on in the City is “socially useless”.
At last week’s conference, Dariusz Wójcik, an economic geographer at the University of Singapore, cited evidence that even at city level, a large financial sector – measured in terms of its share of employment – is bad for growth, once it expands beyond a certain size.
The implication is that, rather than courting and cosseting bank bosses, politicians should be using the levers of tax and regulation to keep them in check.
Former Bank of England chief economist John Vickers and David Aikman, director of the National Institute of Economic and Social Research, attacked the decision to cut capital requirements last week.
They argued instead that, with little room for manoeuvre in the public finances, and risks lurking in the global economy, reserve requirements should be set higher.
“If banks wished to expand lending, they could have done so using their existing capital headroom,” they said. “The most likely practical effect of this weakening of resilience will be higher payouts to bank shareholders rather than increased lending to the real economy.”
For now, with the AI boom in full swing, the banks, and the increasingly powerful private credit lenders, are riding high. But, as Cobham argues, after watching the events of 2008 unfold, “we know that the risks that the financial sector creates will end up being socialised when they crystallise –so we’ll all pay for them”.