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Banks Unchained: the Political Economy of Bank Regulation in the Uk 1945-2015

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Banks Unchained: the Political Economy of Bank Regulation in the Uk 1945-2015 BANKS UNCHAINED: THE POLITICAL ECONOMY OF BANK REGULATION IN THE UK 1945-2015 by Andrew Whitworth A dissertation submitted to Johns Hopkins University in conformity with the requirements for the degree of Doctor of Philosophy Baltimore, Maryland April 2017 © 2017 Andrew Whitworth All Rights Reserved Abstract This dissertation seeks to understand why banking regulation has not led to banking stability. In broader terms it looks at how the state tries to control the market and why this fails. Specifically this dissertation questions why the introduction of new forms of bank regulation in the UK in the 1970s started off recurring financial crises. It examines four case studies in UK bank regulation history from 1970 to 2010 and finds that: 1) Bank regulation operates in a cumulative cycle with bank activity, which can best be understood as Minsky’s financial cycle with a regulatory component; 2) The regulation itself is formed for political rather than economic reasons and represents compromises derived from divergent interests, ideas and institutional forms; 3) These compromises introduce perverse incentives to the financial system which allow banks to circumvent the regulation itself. This leads to a gradual widening of bank activity; 4) The state’s failure to control banking has led it to ape banking’s methods and substitute private (market-based) institutions of regulation for public (control-based) ones. This point follows Polanyi’s idea of double movement to understand how the state and market interact. The result of this cycle is that over time as the scope of banking activity has widened, the state has been less able to control market behavior. Since finance is inherently unstable, this lack of control has resulted in financial instability. The financial-regulatory cycle can be summed up as the fact that banking regulation has political causes but market effects. These are not aligned. The cause of banking instability is therefore ultimately political. i Dissertation Committee Members: Prof. Erik Jones (Faculty Adviser) Prof. Matthias Matthijs (Chair) Prof. Michael Plummer Prof. Filippo Taddei Prof. Jonathan Story (External) ii Acknowledgments It is no exaggeration to say that it would not have been possible for me to complete, or even start, this PhD programme without the support of colleagues, friends, and family. It is a pleasure to acknowledge here the help I have been unstintingly given over the past four years. Foremost is Erik Jones, whose encouragement first started me on this journey and whose patience and rigour pushed me along to its completion. I owe him a huge debt of gratitude for his efforts and kindness, as well as that of his family. No less have I benefitted from the wisdom and experience of my committee members: Matthias Matthijs, Mike Plummer, and Filippo Taddei. They unhesitatingly took on my dissertation on top of their usual workloads and gave me valuable and shrewd advice on how to improve it. Perhaps most important, for me, has been the environment all four have fostered of sociable academic curiosity that the SAIS Bologna Center is famous for. Without this the writing of my dissertation would have been a duller and lonelier task. This dissertation is a product of, and hopefully contribution towards, that fruitful atmosphere of cultured intellectual inquiry. My thanks go also to Jonathan Story, a titan in the field of European integration, for agreeing to come to Bologna to examine me. I gratefully acknowledge the support of the George L. Abernethy fellowship. There are too many friends and colleagues who have helped me to be able to single them all out, but I owe special thanks to Teddy Kahn, Alysson Oakley, Tom Row, Jack Tanaka, and Toni Timoner for their help and advice throughout this process. Deepest thanks are for my parents and brothers, for everything: my education and support, material and emotional. This dissertation is for them. iii Contents Abstract .......................................................................................................................................................................... i Acknowledgments .................................................................................................................................................. iii Contents ...................................................................................................................................................................... iv Part 1: Theoretical core ......................................................................................................................................... 1 Chapter 1: Introduction ..................................................................................................................................... 2 Chapter 2: Literature and Argument ........................................................................................................ 31 Part 2: Historical Case Studies .......................................................................................................................... 69 Chapter 3. Background: Squalid isolation: British finance from 1945-1970............................ 70 Chapter 4. Case Study 1: C&CC and the Secondary Banking Crisis (1970-1975) ................... 88 Chapter 5. Case Study 2: The Banking Act 1979 and the JMB Affair (1979 – 1984) .......... 122 Chapter 6. Excursus: ‘The City Revolution’ (1979 – 1987) ............................................................ 157 Chapter 7. Case Study 3: 1987 Banking Act and BCCI/Barings (1987-1995) ....................... 174 Chapter 8. Case Study 4: From Bank to Bust (1997-2010) ........................................................... 212 Chapter 9. Epilogue: Tragedy and farce: From the financial crisis to Brexit (2010- 2015) ................................................................................................................................................................... 248 Part 3: Results and Conclusion ...................................................................................................................... 259 Chapter 10: Conclusion................................................................................................................................ 260 References and Bibliography ......................................................................................................................... 282 References: Public documents, Archives, Media ............................................................................... 283 Curriculum Vitae ................................................................................................................................................. 302 iv Part 1: Theoretical core 1 Chapter 1: Introduction 2 Prologue Corruptissima re publica plurimae leges Tacitus Banks were born in chains but are everywhere free. This liberty is no welcome thing but is directly responsible for financial instability. Banking has changed from a specific act, cut off from the wider economy except through specific lending and deposit-taking mechanisms, to one which permeates every aspect of modern Western economies. Banks are less constrained in what they are allowed to do. This increase in banking scope has gone hand-in-hand with an increase in the detail of regulation. Having widened the scope of bank activity, the state now attempts to control how this activity is conducted. This dissertation argues that the state is much more effective at widening banking scope than it is in controlling banking activity. Regulation – the state’s attempt to control the market – has become weaker as it has become more specific. If initially banking was severely curtailed in its scope – what activities ‘banks’ were allowed to undertake – but free to do as they liked within that scope (as the period up until late 1970s is here characterized), then as banks have been allowed to undertake more activities they find that these actions are bound by small, changing, and specific rules. The state has given up an attempt at strict control in favor of specific control. In this effort the state is always, inevitably, forced to chase banking innovation and it finds that its method of control is not strong enough convincingly to influence bank activity. The state has become a mere tinkerer inside the market, rather than a determiner of the form of the market itself. The state is trying, and failing, to play the market at its own game rather than force the market to conform to its wishes. 3 The increase in the amount and specificity of regulations (rules) over the past four decades therefore represents a failure of the state’s banking regulation (control). This failure of regulation to control banking activity is the cause of the increase in financial activity that we have seen since the 1970s. The scope of banking has widened, the strength of regulation has weakened, and instability has grown. This dissertation seeks to understand why. Background and motivation The financial crisis showed the world what happens when banking goes bad. The real economy is starved of funds, unemployment rises and public finances come under strain. This is because of the nature of the banking system and its interrelation with the real economy. Banks are peculiar. They are institutions permitted by states to undertake certain financial activities. Primarily they hold deposits and make loans. This allows capital to flow around an economy to be put to productive use. This is the essence of capitalism. In return
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