Corbyn must not be allowed to harness RBS

Ten years after the crisis, using the bank’s funds for political schemes would be disastrous for the economy

Rewind 10 years to just before the catastrophic collapse of Lehman Brothers; there stood Royal Bank of Scotland, which after a decade of rapid-fire acquisition-making had become the world’s biggest bank, with assets and liabilities larger than the size of the UK economy as a whole. Despite what you read today about the RBS chief executive, Fred “the Shred” Goodwin, almost universally portrayed as the quintessential banker villain – as if straight out of central casting – his bank was at that stage still relatively well thought of. Only a few years previously, Goodwin had been made Forbes magazine’s man of the year, while his supposed operational skills had won high praise from both the Harvard and London business schools.

We all know what happened next; today, a much-shrunken RBS is only the 29th largest bank in the world, fined and demonised to destruction and forced to sell off great chunks of the former empire at knock-down prices. It remains deeply unlikely that the taxpayer will ever be fully reimbursed for the £45.5 billion that was spent rescuing this creation from insolvency. Sir Howard Davies, its current chairman, said this week that the purpose of the capital injection was to save the UK financial system from collapse. It wasn’t intended as a financial investment. This is true, but the possibility of a loss was not even remotely contemplated at the time, when ministers excused the bailout by claiming it might eventually deliver a handsome return. It has not.

All the same, RBS is today a much safer bank than it used to be; it’s back in profit, it has started paying dividends again and, almost unbelievably, given that it was waferthin solvency buffers that brought the bank to its knees, it is now reckoned to have such an excess of capital that directors are considering using it to buy back some of the Government’s remaining stake. Is that entirely wise, in view of its history?

Whatever the answer, there is an interesting explanation for the urgency with which the Treasury is attempting to rid the taxpayer of its controlling stake, notwithstanding the likely losses involved. The explanation also speaks to some of the reasons why RBS wasn’t fully nationalised in the first place, as many said it should be at the time. It is because politicians do not make good bankers, though it might reasonably be argued that even the most hairbrained among them could not have done a worse job than Mr Goodwin.

All the same, it is an abiding principle of any capitalist economy that you do not want the politicians in control of private credit allocation. Even the supposedly impartial involvement of regulators in bank lending leaves much to be desired. Well intentioned their interventions might be, but almost inevitably they lead to distortions in the market and to misallocation of capital, sometimes catastrophically so, as occurred with US mortgage lending ahead of the crisis. This was thought to be one of the least risky forms of lending, and carried correspondingly marginal capital requirements. The politicians positively revelled in the financial innovation that allowed apparently everyone, however penniless, to achieve the seemingly ever upwards escalator of home ownership.

Yet bad ideas die hard and today Jeremy Corbyn’s Labour promises to use the Government’s controlling stake in RBS, should it ever get the chance, for politically directed lending. A Labour Party commissioned review of investment, monetary and banking policy by GFC Economics, published last June, proposed making RBS into a fully fledged “development bank” specifically mandated to support small and medium sized enterprises. Banking supervisors would meanwhile direct lending to investments that might best enhance productivity – for which read any pork barrel enterprise or vanity project most likely to deliver votes.

The quicker the Treasury moves to sell down its stake, the less likely it is that this strategy can be pursued, since without control, Labour would struggle to make RBS do its bidding; the commanding heights of the economy would be withheld.

None of this is to deny that Labour’s ideas are potentially popular. Since the crisis, policymakers have been focused almost entirely on restoring the ex-ante status quo, as if all that existed before the crisis was the best of all possible worlds. This it was plainly not. The idea that nothing has changed as a result of the crisis, and that what’s needed are radical ideas to transform the financial system fundamentally for the public good, is a powerful one with plenty of popular appeal.

But it won’t work. Fractional reserve banking is at the heart of the success enjoyed by Western economies these past several hundred years. Occasionally it blows up, doing a lot of damage, and imperilling the capitalist system in the round. But warts and all, it works. A healthy economy requires banks to take risk and sometimes to fail. We’ve just had a monumental lesson in what happens when they get out of control, but the trick is to dethrone the bankers, not to execute them.