British banks and the utility model

During the summer and before the credit crunch morphed into a global financial crisis, I heard Vince Cable speak at an Editorial Intelligence event.

The debate focused on the impact of the credit crunch and what it all meant. A remark by Cable stayed with me and has since become more and more relevant. He said there were two potential models for British banks: an open market where banks collapse and new entrants emerge quickly or a regulatory regime that treats the banks like utilities.

He didn't elaborate on this. Nor did he offer a view on which was best or the most likely to happen.

After the events of September, it appears that the utility model is the one that will win out. And if you think about it, we have been treating our banks like utilities for quite a while.

In a free market one would expect businesses to be set up, fail and for new businesses to enter the market place. You might argue that a sign of the market functioning is this very failure. The business woman has an idea that a product or service will work and she takes it to market. Only then will she know if it is something that the buyers want. They might not. She will then go out of business. Alternatively, buyers might really like it but the way the product or service has been taken to market is flawed and the business model needs to be adapted. To make all this work, you need ease of access to the market.

One thing Cable did point out was that there hadn't been a brand new bank come into the market for a very long time. No doubt there are various reasons for this but the obvious one would appear to be that once banks have established themselves in the market place people trust them. They are not about to rush to a new small bank and deposit their money.

If entry into the market is restricted and if the supply of credit is as crucial as the supply of electricity, one can begin to understand why the utility model has such appeal. Once you view a bank in this way, the regulatory arrangements will be significantly different to ones for other organisations operating in a market. The most important feature being that you will do your utmost to regulate the bank in a way that means it won't fail: directly contradicting an open market.

To the proponents of free and open markets this could be seen as rather depressing. They will be asking where will the innovation come from, what about the buyer’s choice and what about wealth creation?

If large banks are regulated as utilities this does not mean that smaller lending organisations cannot enter the market. Credit unions seem to be doing relatively well, the mutual may make a comeback and the financial markets will no doubt find other models to lend, borrow, securitise and derive wealth from.

It is highly likely that the new regulatory framework that emerges in the UK and elsewhere will treat the large banks in this way. If the smaller lenders and new entrants can be regulated more like banks and not utilities, until they reach a certain point, then we might find we have a flexible and workable financial system.