Making good from bad in this crisis

We should be thrilled that their businesses have, within a year of being rescued by the taxpayer, once again become highly profitable, not by the skill of their management but by virtue of their ability to use their position at the heart of the system to overcharge their customers - be they those who seek to borrow money, those who want to change pounds into foreign currency or those in the corporate sector who need help to raise new capital.

The reason we should be so pleased by these developments is that they prove conclusively bankers are incapable of reforming themselves. It follows therefore that we will have to do it for them, and their behaviour removes any doubt about whether or not this is the right thing to do. Their "business as usual" approach gives a new dimension to the expression "reversion to the mean", if only because they rarely come much meaner. Their similar behaviour in the past set off a crisis that continues to do huge damage to people and businesses round the world, but most refuse to accept that. The few who do accept it still see no reason to change. Their daily behaviour demonstrates that none of them believe they are drinking in the Last Chance Saloon.

Professor John Kay, one of the leading financial academics in the country, this week gives us his thoughts on how the system should be reformed in a paper published by the redoubtable think-tank the Centre for the Study of Financial Innovation*.

We will come to his proposals in a minute, but what is so rewarding in his analysis is that he does not confine it to the dry world of financial stability, but points out how the same structures in banking that brought about this disaster are also responsible for the appalling customer service which characterises the industry. What is so important about his proposals is that he believes they could "establish a retail sector focused on the needs of customers rather than on the promotion of products and the remuneration of producers".

He adds: "We could look forward to an industry in which new technologies are used not just to reduce costs, but to deliver better services. We should establish a market in which customer satisfaction is the measure of success. That would be an outcome very different from out recent experience. But it is an outcome we can and must achieve."

Interestingly, most senior bankers will privately admit that they are terrible at customer service, but none of them have ever cared enough to do anything meaningful about it because they can make much more money, and it is more exciting doing other things. The heart of Professor Kay's proposal is to make this dereliction of duty impossible by splitting up these financial conglomerates into narrow banks that would deal with retail deposits and loans and the payments system and everything else.

The narrow bank would be tightly regulated, as are other existing utilities such as water, telecoms and electricity, and in effect guaranteed by the state to reflect that fact that properly functioning utilities are a vital part of the modern economy.

The rest of what is currently lumped in with banking - the dealing, the trading, the "casino" operations - would be a quite separate private-sector activity with the opportunity to take risks and make big profits but with no doubt that it would be left to go bankrupt if their managements got it wrong. Risk control would be managements' responsibility, not that of the regulator - and they would pay the price if they failed.

Kay reminds us that the bankers have extracted subsidies and guarantees of extraordinary magnitude from the taxpayer without substantial conditions or significant reform - and because of that, if we allow them to continue on their chosen path, there will inevitably be another crisis. That is why "we must not let a good crisis go to waste" but instead seize the opportunity while it exists to change the system for the better.

He warns us too that because the central problems of banking - the piling-up of ideologically conflicting activities within one vast organisation - have not been addressed, there will be further crisis, not identical of course, but with the same, common roots. But a public that is already angry will be in no mood for an encore. The great danger is that populist politicians will harness that anger to mount a frontal attack on the whole market system.

Disgust with bonuses leads to disgust with banking, and it is then but a small step in the public mind to the destruction of faith in business in general. Yet, as Kay says, " the triumph of the market economy was one of the defining events of out lifetimes". We should be careful not to throw it away and to that end "it is time to turn the masters of the universe into servants of the public".

* Narrow Banking: the Reform of Banking Legislation by John Kay. Available through the CSFI website csfi.org.uk, £25.