Bangor Business school
Time for a state bank in the UK

The government’s stake in a number of the country’s major banks is only a temporary phenomenon. Conventional wisdom has it that we should cash in that investment as soon as possible. Are we being too hasty?, asks Professor Philip Molyneux of Bangor Business School.

State-owned banking is a long-established tradition in European countries although it has experienced a marked decline over the last 20 years or so.

By the mid-1980s over half of the French, German and Italian banking systems were state-owned, typically via national government ownership of major commercial banks (France and Italy) or federal ownership of savings banks (German). Liberalisation from the early 1990s led to widespread privatisation of the commercial banks in Italy and France so that the role of state ownership nowadays is miniscule.

Nevertheless, over half the German retail banking market still remains under state ownership. Further afield, the largest deposit-taker in the world was the Japanese Post Office (until privatisation in 2008), and even in the US the massive governmentsponsored enterprises (GSE’s – Fannie Mae, Freddie Mac and Ginnie Mae) financed half the country’s mortgage market (until their collapse in September 2008).

Government ownership therefore has a long tradition in banking across a wide swathe of institutions and countries.

In the UK, some may recall the Girobank, established by the Wilson Labour government in 1968 to provide banking services to the financially excluded. There is also National Savings offered via the Post Office or online – for tax-exempt savings (and cheap government funding) – but up until the banking crisis, the state only played a minor role in the financial system. This has all changed.

At the beginning of February 2010, UK Financial Investment (UKFI) reported that the state owned £67 billion of the banking sector; holding an 83 per cent stake in RBS, 41 per cent in Lloyds and 100 per cent of Northern Rock and Bradford & Bingley. The UK effectively is a state banking system and while the head of UKFI, Robin Budenberg, has argued that breaking up the banks would reduce the return to taxpayers, there is no doubt that the plan is to privatise these institutions in one form or another and give returns to the Exchequer.

While privatisation is hardly an innovative option – it may also be hasty. State banks can perform key functions in a financial system that private banks cannot. First, they can fill gaps in the financial system – holes left by the private sector. For instance, a state bank can offer subsidised credit to SMEs, mortgage borrowers (as in the case of the US GSEs) or to selected strategic business areas or regions. Effectively various government agencies offer these types of services at present – they could easily be offered via a state bank.

State-owned banks can also coerce their private sector counterparts – taking the lead in monetary policy transmission, out-competing private banks in certain sectors if need be and taking no action in others. This coercive power can be used to cajole the private sector to behave in a way deemed more socially responsible than the market would dictate.

Finally, other arguments in favour of state banking relate to a variety of public good issues such as controlling monopoly power, social costs associated with private sector banking (greater volatility and incidence of crises) and so on. Following the 2008 banking crisis, the arguments in favour of state banking look far less eccentric then they would have in the mid-2000s when UK banks were earning record profits and reporting historically low risk positions. How things have changed.

The UK’s Independent Banking Commission reports in September 2011 and there has been much discussion to date on restructuring the banking sector via separating/ ring-fencing retail and investment banking; this may help reduce risks (in the former at least), make the new institutions smaller and possibly reduce leverage. Another alternative, of course, is to establish a major state-owned bank that policymakers can use to help establish greater competition in the sector, direct lending to credit-constrained SMEs and also coerce the private banks into appropriate welfare-enhancing behaviour. Given the arguments advanced to date, the case for a major UK state bank is, in my view at least, just as persuasive as the break-up of failed private banks.

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