Banking system is not fail-safe but is in better shape than 10 years ago

ALMOST every part of the way British banks were regulated was found wanting in the crisis and the rules have rightly been completely overhauled.

The new regulatory system is by no means perfect but the banks are much less susceptible to the kinds of problem that they encountered in the crisis. All banks work by taking customers’ deposits and lending them out. That lending is done for a fee and this gives the bank’s owners and depositors a return.

Obviously banks need to be extremely careful how much they lend and to whom. Banks like Northern Rock were lending way too much and covering the shortfall relative to their deposits by borrowing from fickle, shortterm wholesale markets.

When that funding disappeared, the banks could not borrow to cover their activities and didn’t have enough of a liquidity cushion so they couldn’t fund themselves.

At the most basic level, this very risky model of lending out far too much relative to the deposits and other stable funding sources you hold has been completely vanquished.

The bank stress tests mean that lenders need to have proper capital and liquidity buffers in place for times of crisis. They are much more rigorous than the European system which gave a clean bill of health to a bank that duly failed months later. The tests can’t cover all eventualities but they have teeth and regulators have the power to sort out problems that the tests uncover.

Of course, there’s still risk left in the banking industry. Regulation means most of the UK banks have similar business models now: overwhelmingly focused on UK retail banking.

This means that they will all suffer if the UK economy experiences a downturn. But banks have always followed an economy up or down. The difference now is that they should be able to better withstand a downturn.

Similarly, everyone focusing on the UK has meant banks competing heavily in quite a narrow market. That’s raised concerns about the amount of lending going on in certain areas. The regulator has issued warnings but this is reassuring because it shows that they’re doing their job of supervising the banks properly.

A banking system can never be fail-safe but the UK’s is in much better shape than 10 years ago.