10 THE NEED FOR BANKING REGULATION

Back in 1766, Adam Smith called for regulation to stop some banking tricks, ‘When a run comes upon them they sometimes endeavour to gain time by paying in sixpences and they would be precluded by this regulation from this discreditable method of evading immediate payment’.

Today’s banks may not pay in sixpences but they have created new and ‘interesting’ ways to evade immediate payment. Take, for example, the cheque clearing cycle.

DEFINING IDEA…

I hate banks. They do nothing positive for anyone except take care of themselves. They’re first in with their fees and first out when there’s trouble.

~ HARVEY GOLDSMITH, BRITISH MUSIC PROMOTER

In 2000, a government-appointed banking review led by Don Cruickshank highlighted, among other things, cheque-clearing times. According to Cruickshank the system was run like a ‘cartel’, meaning the banks joined forces to proliferate a united explanation as to why it took up to ten days to clear a cheque. Meanwhile, it was estimated the banks made up to $30 million in interest by ‘evading immediate payment’ through the clearing system.

Even the then Governor of the Bank of England, Mervyn King, expressed ‘disappointment’ at the time it took for cheques and electronic payments to be cleared. The problem is now partly resolving itself as cheque usage declines. In 1999, 2.8 billion cheques were written and that figure is expected to fall to 1.7 billion in 2009.

The Office of Fair Trading in the UK also became involved and, as of November 2007, money paid into an account by cheque now starts to earn interest, or be offset against an overdraft, within two working days, rather than three.

Smith went on to say that banks, ‘would be obliged to keep at all times in their coffers a greater quantity of cash than at present; and though this might no doubt be a considerable inconveniency to them, it would at the same time be a considerable security to their creditors’.

Following the banking difficulties of late 2008, few creditors felt any considerable security about their savings, so much so that the Financial Services Authority (FSA) increased the compensation limit on saving deposits from £35,000 to £50,000 in an effort to calm a nervous public.

According to Smith, ‘the coffers of the bank resemble a pond, from which though a stream is continually running out, yet another stream is continually running in, fully equal to that which runs out; so that, without any further care or attention, the pond keeps always equally, or very nearly equally full’. Yet in modern times this didn’t happen… Apparently during the height of the lending frenzy, US banks lent $30 for every $1 held in deposits. In the UK and Europe the ratio was $50:$1, while in Australia, tighter regulation limited it to $13:$1. Meanwhile, in Iceland a staggering $300 was ‘running out’ for every $1 ‘running in’!

HERE’S AN IDEA FOR YOU…

Even with increased government guarantees, you need to ensure all your savings eggs are not in one basket. Divide them up across different banking institutions to make sure they are not part of the same group. Remember, a bank may have a different high-street name but be owned by the same group and compensation will only apply per group.