We need to break our unsecured banking system out of its Victorian past
THE UNSECURED nature of the UK banking system has long troubled both me and my company, and we have discussed the situation with the Bank of England on several occassions. Concerns over bank capital positions have also recently been reignited. Barclays, which releases its half-year results today, is one of the banks identified by the Prudential Regulation Authority (PRA) as having a shortfall in its equity buffer for absorbing future potential losses. It is expected to set out plans to meet tougher new rules.
It should, however, be possible for banks to move towards full collateralisation for all significant deposits, with funds secured against high quality securities. The major clearing banks have consistently argued against such a development. But we remain confident that collateralisation could be achieved, and that it would result in a more stable system, potentially lower capital requirements for banks, and therefore more bank lending.
The Share Centre is responsible for about £150m of customer trust status deposits. Our first priority is their safety. Although the Financial Services Compensation Scheme (which guarantees deposits of up to £85,000 per customer per financial institution) applies to individual customer balances, we take our fiduciary responsibility seriously: hence our search for secured deposit facilities.
Over the past couple of years, we have put in place fully collateralised arrangements with two building societies, covering about 20 per cent of our customer trust status deposit balances. These are secured with high quality mortgage deeds, with a margin of 50 per cent over deposit value, marked to market and refreshed monthly. As this arrangement shows, collateralisation can be achieved where there is good will and a determination to establish the necessary systems.
The prize for establishing a comprehensive structure of collateralisation for significant bank deposits is very large – both in terms of systemic stability and economic stimulus, and there is no shortage of collateral in bank vaults. The key challenge is to get it working.
Our solution would see Euroclear, the user-owned central securities depository, at the heart of any such system, providing a fully electronic mark to market collateral system. The costs need not be excessive, and would be covered through modest differentials between secured and unsecured deposit rates. The efficiency of the security clearing system would allow the facilities to be available for both on-call and term deposits.
We propose that the PRA should establish lower capital ratio requirements for banks making use of a collateral system, providing an incentive to switch over. They would be encouraged to seek collateral or guarantees on all significant lending to corporate or personal customers, and this again would be encouraged through flexible capital ratios.
The potential for electronic collateral has changed greatly over the past 20 years. But apart from interbank transactions, where collateral is more common, the banking system remains locked in its Victorian past. If a flexible collateral system had been present, much of the chaos of the financial crisis could have been avoided. It is not too late to make this change now.
Gavin Oldham is chief executive of The Share Centre.