Mervyn King speeches used to be one of my favorite central banker speeches. He has not been talking regularly for a while now and the speeches have also been just ok types.
He makes a strong comeback with his recent speech and I hope he returns to top form. He hits hard on banks and the damage they have created to the economy.
The United Kingdom faces two fundamental long-run challenges. First, to rebalance the economy, with more resources allocated to business investment and net exports and fewer to consumption. That is consistent with the need – now widely accepted – to eliminate the large structural fiscal deficit and to raise the national saving rate. It is part of a need for a wider rebalancing of domestic demand in the world economy away from those countries that borrowed and ran current account deficits towards those that lent and ran surpluses.
Second, both the structure and regulation of banking in the UK need reform. Banks increased both the size and leverage of their balance sheets to levels that threatened stability of the system as a whole. They remain extraordinarily dependent on the public sector for support. That was necessary in the immediate crisis, but is not sustainable in the medium term.
Further he adds
Tonight I want to focus on the second of those challenges – reform of the structure and regulation of the banking system. Why were banks willing to take risks that proved so damaging both to themselves and the rest of the economy? One of the key reasons – mentioned by market participants in conversations before the crisis hit – is that the incentives to manage risk and to increase leverage were distorted by the implicit support or guarantee provided by government to creditors of banks that were seen as “too important to fail”. Such banks could raise funding more cheaply and expand faster than other institutions. They had less incentive than others to guard against tail risk. Banks and their creditors knew that if they were sufficiently important to the economy or the rest of the financial system, and things went wrong, the government would always stand behind them. And they were right.
The sheer scale of support to the banking sector is breathtaking. In the UK, in the form of direct or guaranteed loans and equity investment, it is not far short of a trillion (that is, one thousand billion) pounds, close to two-thirds of the annual output of the entire economy. To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.
He points to 2 broad approaches to fix banks:
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Accept some banks are too big to fail and limit the probability of them failing
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Limit the size of the banks
He prefers the 2nd approach as first has limitations and we can never be sure. For 2nd he suggests 2 ways – Narrow Banks or separating commercial banking from other bank activities. He says banks are like utilities and like we do it for utilities (separating main activities from others), we should do it for banks. Then only regulation is possible.
These are quite different ideas from a Central banker based in UK. They have been pretty much shaken up by the low morals in banking/finance industry.
Mostly Economics 
