Grave danger of bank rescues

Unfortunately, this complacency of just a few years ago now looks dangerously misplaced. We have seen ample evidence in the past 12 months of the government's ability to use the tax system to cause maximum uncertainty for minimum benefit.

Who knows what long-term damage may eventually be done to the City by the non-dom and capital gains tax changes, to say nothing of the perverse incentives for multinationals to relocate offshore? What we do know is that London's reputation has been damaged and the confidence of overseas participants undermined.

If one own goal is seen to be good in Westminster, then two is clearly better, so now it is the turn of regulation. Today sees the close of consultation on the government's proposals to change the law to deal with the next Northern Rock — the creation of a Special Resolution Regime, which would give the authorities unprecedented powers to move in and take over a bank they think may be about to fail.

And so rushed and badly thought-through are its ideas that if they come into law without massive amendment, they could be as damaging to London's image as Sarbanes-Oxley has been to New York.

Part of the problem is motivation. Everyone accepts that Northern Rock highlighted flaws in the current system that could usefully be rectified. The difficulty is that the case for saving a bank arises only if it poses systemic risk; if its failure will cause contagion which will bring failure in others. It is not right to rescue everyone willy-nilly because if banks seriously think they will get bailed out no matter what, they have no incentive to behave sensibly.

However, it is difficult in advance to know what is likely to be systemic, which makes it all the more astonishing that this legislation could be brought in, ostensibly to reduce systemic risk, without any attempt to define or debate what it is.

Except that it is not astonishing if you take the view that concerns about threats to the system are merely a figleaf, and what Government is really concerned about is avoiding political risk — the embarrassment that comes from television pictures of voters queuing in the streets in Labour heartlands to rescue their life savings. It is too easy to believe that the real driver for the legislation, and the haste with which it is being pushed through, is that this must never be seen on television again, and certainly not between now and the next election.

The trouble is that this created an incentive for the authorities to move in early at the first hint of trouble, although that means riding roughshod over the rights of the owners of the business, the shareholders. Hence the concern, among others, of the Association of British Insurers, which speaks for £1500 billion of policyholders' funds, and which is frankly alarmed at the lack of respect the proposals show for basic shareholder rights and contract law.

So, as a very minimum, it wants the Financial Services Authority's power to trigger an intervention to be exercised not early on, when it first begins to have doubts, but only when the situation is so bleak that there really does seem to be no other way out.

Before that button is pressed, however, the ABI wants it to be compulsory that the shareholders are consulted to see if they have an alternative solution and/or would provide more capital. It makes the hugely important point that if shareholders are not given the opportunity to be part of the process, then they are bound to feel resentful when their asset is confiscated.

Overseas shareholders in particular are likely to see it as little more than state-sponsored theft, the more so as, having not been included in the process or given the information, they can have no idea whether the bank is genuinely in trouble.

Similarly, when a bank is taken over, the ABI wants the rump to be run to maximise the remaining value on behalf of its erstwhile owners, rather than closed down and swept under the carpet as fast as possible to minimise embarrassment. Also, if the worst does come to the worst and the thing is taken over, the ABI wants a fair, impartial and transparent compensation scheme for shareholders. For the absence of doubt this means it does not want one like the government has invented for Northern Rock, where the rules and criteria are so biased that it is highly unlikely there will be any payout at all.

This really does matter. This protection of shareholders' rights is important, because it is the touchstone of the rule of law. Financial centres cannot function without legal fairness and certainty; witness the problems faced by Russia where application of the law seems capricious and arbitrary. Rights in this country which have evolved over hundreds of years and which are fundamental to our system should not be casually undermined for a few months of political expediency. If they are, if this legislation goes through without serious amendment, it will potentially do huge damage to London's international reputation. That is a risk we really should not be prepared to take.