A society that creates and spreads wealth in a way that builds economic security must be underpinned by financial security. That means we need secure, high-quality banking and strong, safe pensions. We need to take the 'casino' element out of our financial system and replace it with safe, reliable – boring – financial security.
The lesson for banking in this country could not be clearer; we need a banking system that is built on trust from customers which comes from banks which care about their customers. It must be a safe banking sector in which your savings are secure and which supports you when you need support – perhaps to get a mortgage to buy a house or to get a loan to start a business. And we must never get into the position again where a corrupt banking system threatens to bring down not only all of our personal finances but the whole economy along with it.
Achieving this is straightforward. We need small, responsive banks which are rooted in their community and which pose no systemic threat to the economy. Once again, this is a model which is normal in western European countries where community and mutually-owned banking is often the dominant model of banking for households. In fact in both Germany and Japan a large majority of the banking market is local or regional banks and this sector makes up a third of the banking sector in the US.
The balance sheets of the big banks (all their debts and assets) contain an enormous amount of risk – they are still unstable and vulnerable to economic shock. This is a problem made much worse because they remain far too large and each of them individually remains a threat to the entire economy if anything happens to their liquidity (the amount of cash they actually hold). Any system of retail banking (providing current accounts, mortgages and loans to households and small businesses) which is based on these existing banks will be unstable and will require the public to underwrite that instability. Banking is built on confidence but the existing banks give no reason for customers to feel confident and so they need a 'guarantee scheme' funded by taxpayers to reassure customers (and other lenders) that if the bank collapses, the public will pick up the pieces. This is called 'lender of last resort'.
But a Common Weal Scotland cannot be based on an unstable banking system which no-one trusts and which can function only if it is glued together with unlimited guarantees of money from the pockets of the public. We have already seen that the big banks have failed to provide sources of patient funding for large-scale national investment. Those big investment projects (in both the public and private sectors) should be supported by a National Investment Bank (see above).
Then we need to offer customers a secure, stable, trustworthy and reliable retail banking service – and the overall system that these banking services make up must not pose unacceptable systemic risk. As we have seen, the existing banking sector does not offer that. It will therefore be necessary to offer customers a better alternative.
That alternative will be boring and safe. It will offer normal, high-quality current account services for households and individuals where you can keep your money, set up direct debits to pay your bills, get money out from cashline machines, pay for things using debit and credit cards and everything else you'd expect from a bank. It would also offer a normal loan service for arranging bank loans for customers when they need them. And it would provide secure mortgages to home-buyers. In fact, it would do all the things that we expect from our bank – except it would be local and locally managed so you will have a bank manager and a staff in the bank who are solely responsible for your account. And it will be the same manager and same staff you deal with next time too.
But perhaps above all these banks will be non-profit generating. They will operate on mutual principles so everyone who keeps money in the bank is a part owner and all profits are put back into the business. There would be no incentive for bankers to make a profit at the expense of their customers and every incentive for them to keep long-term trusting relationships with their customers. It was the hunt for profit at any cost that brought down the UK banking system. It must not be allowed to happen again.
The system will be created with two overlapping kinds of provision. First of all we should replicate the effective German system. Here 43 per cent of the banking market is made up of local and regional publicly-owned banks. Each of the existing local authorities would set up local/regional banks designed to provide precisely the locally-focused, locally-managed, safe and secure banking that people want and need. There would be many branches across the local authority area and indeed it would be possible to provide banking facilities for smaller communities from existing local authority premises.
In addition to this sector the development of smaller mutual banks and credit unions will be supported. These can provide a similar but different kind of service for their members and can be tailored to specific needs. For example, in poorer communities it may be credit unions that provide the kind of micro-finance loans which are currently delivered expensively by pay day loan companies (these companies that target the already limited wealth of the poor to make giant private profits for their owners should no longer exist in a Common Weal Scotland).
All of these banks would then be linked to each other through an association and service provider company that is owned jointly by the independent local banks. This association and shared company will ensure easy interaction between these different banks so where there are efficiencies of scale (benefits from doing things collectively) there is a vehicle for doing that. It would also set strict regulation and restrictions on community banks, so that, for example, community banks could not expand beyond a permitted geographical boundary to prevent the tendency towards monopolisation in banking. Clear societal goals would have to be strictly adhered to so, for example, community banks couldn't fund local projects which are damaging to the local environment.
Once a system of community banking is in place which offers supportive and secure banking services, a government education effort will be initiated to explain to domestic customers the benefits of moving their finance to these community banks. Credit unions and smaller mutual banks and building societies, subject to their own set of strict rules and regulations, will pick up other customer needs.
For most local businesses the community banking system will also meet their needs. They will be able to get business account services and access to borrowing in an environment where they can develop long-term relationships with their bank. It is also possible that these banks may provide some of the sources of finance for local investment in infrastructure – although large-scale, riskier lending must be discouraged.
The community banking sector will be entirely independent and run locally according to local need. It will not be centrally managed and nor will it have centrally-set targets (although within the strict regulations of the sector). However, there should be an open flow of information between the banks and the National Investment Bank to enable an overview to be taken of both the levels of investment being made across the country and to identify any emerging systemic risk resulting from the individual actions of a lot of different banks. The central bank would also issue direct guidance to banks on the amount of credit they can issue so as to prevent risky credit bubbles.
Once this banking system is in place it should be made clear that it is the public sector's responsibility to ensure the value of savings and to ensure that suitable amounts of credit are available in the wider economy. It is not the public sector's job to guarantee the business of any individual bank or financial service company. A Scottish central bank (if we have one) or the National Investment Bank (if we don't) should guarantee individual savings are secure and provide loans if banks don't but it should not offer a blanket lender of last resort facility to all banks in all circumstances. Banks which have made commercial decisions, that have acted speculatively, that have become 'too big to fail' and so on can't possibly imagine that the general public will underwrite their behaviour indefinitely. Private-sector banks are free to take risks – as long as the risk is to the individual bank or enterprise and not the economy as a whole.
To ensure this, we therefore have to introduce regulation on private-sector banks so that the wider public are protected from their speculative activities by a firewall. The first measure is to re-introduce a new form of the 'Glass-Steagal' act, a legal separation between investment and commercial banking. This means risky investment decisions are separated from the bank accounts of ordinary customers. This may require Government to have the legislative power to break up big-banks themselves that are measured as a threat to the wider economy and the financial system as a whole because of their size.
Secondly, we need to introduce credit controls which specifically limit asset-based credit creation and speculation so as to avoid asset-based inflation, especially in the housing market, and discourage excessive risk-taking in the financial markets. Put simply, banks can't just create new money to push up prices and increase profits. To do this a higher reserve requirement for assets would be set. By setting the rate at a higher level than for, say, deposit liabilities means that the cost of short-term loans and risky investments is raised relative to long-term loans. This can encourage more socially useful, productive financial investment.