In his seminal book Scottish Banking: A History 1695-1973, Professor Sydney Checkland wrote that the achievements of the Scottish banks were ‘remarkable’ over the course of nearly three centuries.
He added that between 1695 and 1973, the country’s banks: “provided what is probably the widest spread branch system in the world, with managerial service at practically every point of the country, with the cheapest current accounts and all other facilities either free or at very low rates, all without benefit of subsidy or special treatment. A tremendously loyal and efficient staff has made these things possible.”
He continued: “Scottish banking is run by Scotsmen, raised within the system and the country it serves. It provides a means of defining a banking sub-region within Britain that coincides both with a historic national identity and a meaningful economic unit.”
The 1970s were a time of serious economic malaise, dogged by frequent strikes, rising unemployment, and severe inflation. However for banks the 1970s were arguably a halcyon era. They were perceived as prudent, solid and reliable Institutions whose interests were aligned with those of the communities they served.
Bank managers were perceived as Captain Mainwaring figures, the stolid British gentleman characterised in the BBC’s popular comedy Dad’s Army. The idea they would engage in activities such as systematically ripping-off their customers, ‘gaming’ financial regulations by disguising risk, rigging benchmarks like Libor, plundering business customers’ assets to strengthen their own capital, or passing off bonds that were known to be dross as “AAA” in order to make a fast buck for themselves or for their institutions, would have been unthinkable.
Historically, there were plenty of factors that drove principled behaviour in the banking industry. One was that, until the Joint Stock Act of 1844 and the Limited Liability Act of 1855, partners and proprietors of most banks risked losing everything if the firm they owned or managed went bust. After Ayr Bank collapsed in 1772, the Duke of Buccleuch was forced to sell his 1,520-acre Adderbury estate, including the 56-room country house where Adam Smith had been a frequent guest, to cover his unlimited liability in the bank.
As the Bank of England’s chief economist Andy Haldane puts it unlimited liability “generated potent incentives to be prudent with depositors’ money.” And, inThe Wealth of Nations, Smith predicted that firms with more diffuse ownership were more likely to get into trouble.
"The directors of such companies [joint-stock companies] being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private co-partnery frequently watch over their own.”
The structure of banks and societal restraints didn’t always prevent them from going off the rails, however. In Scotland, the collapses of Ayr Bank (1772), Western Bank of Scotland (1857) and City of Glasgow Bank (1878) were caused by a mixture of reckless lending, under-capitalisation, grossly incompetent or criminally negligent management, and sometimes outright fraud — as well as complacent partners and proprietors.
More broadly, in the 18th and 19th centuries, Scottish banks have also been accused of serially breaking the law. The American anarcho-capitalist economist Murray Rothbard, says they did this by periodically failing to honour the convertibility for their notes to so-called “specie” (gold and silver coins), a pattern of behaviour he describes as their “less-than-noble tradition of non-redeemability”.
In the tightly-controlled post-war era, from the 1950s to the 1970s, a number of shenanigans also occurred. When providing insurance policies to customers during those decades, branch managers at RBS would help themselves to the commission paid out by the insurers. According to one ex-RBS staff member, the managers, who at the time ran their branches as personal fiefdoms, regarded it as ‘fringe benefit’ — even though “some were making more out of that than they were from their salary”. Also during this time, cartel-like behaviour was rife — the Committee of Scottish Bank General Managers set interest rates for all Scottish lenders, eliminating price competition.
According to former banking insiders, a favoured mantra of Charles Winter, RBS’s chief executive from 1985 to 1992, was that RBS existed to look after its staff first, its customers second, and, if any crumbs were left on the table, its shareholders last. That was turned on its head by his successor, Sir George Mathewson, during whose tenure ex-insiders say the mantra became ‘shareholders first, shareholders second, and shareholders third’.
I would argue that prioritising the interests of shareholders to this extent — a policy which was advocated by Chicago School economists such as Milton Friedman in the 1970s and which was widely adopted across the business world from the 1980s — brought spectacular if volatile profits, but often at the expense of customers and staff, who sometimes got metaphorically shafted.
Consolidation in banking also, indirectly, led bankers to behave badly, as less competition and choice gave greater scope for abuses to become ingrained. The Bank Charter Act 1844 — which denied new banks the right to issue notes, putting the brakes on new bank formations — was a key milestone on the path towards banking becoming an unaccountable oligopoly. From late Victorian times, the banks also benefited from an unwritten compact with the Bank of England. If they responded quickly to “the Governor’s eyebrow”, they would be protected from too much competition.
Consolidation accelerated over ensuing decades. In 1896, twenty smaller banks merged to form what became Barclays. In the 1960s England’s ‘Big Five’ became the ‘Big Four’ with regional banks Martins, District Bank, National Bank, Glyn Mills and William Deacons swallowed up. Eight Scottish banks became three — RBS, Bank of Scotland and Clydesdale Bank. Then, under New Labour, the Monopolies & Mergers Commission nodded through RBS’s takeover of NatWest and Halifax’s purchase of the Bank of Scotland. Other competition-eroding deals followed, including Lloyds TSB’s rescue takeover of HBOS in 2009 and Santander’s acquisitions of Abbey National, Bradford & Bingley and Alliance and Leicester in 2004-10. Britain had nine stock-market list banks before the crisis of 2008. Today they have merged into five.
Sir Donald Cruickshank, a former regulator who conducted a review of the banking sector in 2000, does not believe all this consolidation should have been allowed. He argues that New Labour missed a trick in not giving the Financial Services Authority, the super-regulator it founded in 1997, any powers over competition. Actively regulating to prevent the formation of cartels, oligopolies and monopolies is one of the most reliable ways of ensuring banks behave themselves and customers get a fair deal, according to Cruickshank.
When US president Richard Nixon ended the US Dollar’s convertibility to gold in August 1971, effectively scrapping the Bretton Woods agreement, banking arguably became increasingly detached from financial reality. Professor Richard Murphy of City University says, “Money became entries in a computer, without anything like gold to back it up.”
Liquidity ratios were relaxed and a genie of free-floating, market-traded currencies was unleashed — which in turn gave rise to huge markets based around hedging the risks created by currency uncertainty, as well as a rising tide of credit. Then in 1986, with “Big Bang”, the Conservative government of Margaret Thatcher further deregulated the City of London, enabling high-street banks to acquire stockbroking firms, merchant banks, insurers and fund management firms, giving rise to financial-services conglomerates which were rife with conflicts-of-interest, which would have been anathema to believers in truly free markets and fair competition like Adam Smith.
Rather than focus on the needs of their high street customers, the banks increasingly ran their retail arms as ‘cash cows’, focusing instead on more lucrative and less socially useful investment banking activities — including a closed loop of derivatives trading and an ever-expanding web of bets and counter-bets, which dramatically boosted profits but also fuelled systemic risk. The dog-eat-dog ethics of investment banking seeped through to high street banking, with retail staff incentivised to ‘cross-sell’ products that would be profitable for the bank but deleterious to account holders.
In 2011, Professor Karel Williams of Manchester's Centre for Research on Socio-Cultural Change (Cresc) told The Observer: “Deregulation created a sectional interest in finance, which is beyond political subordination."
Similar changes were introduced in the US. In 1999, Bill Clinton’s administration repealed the Glass-Steagall Act, enabling investment banking activities to coexist with retail banking under the same ownership for the first time since 1933. The Clinton administration also refused to contemplate even modest regulation of the derivatives market when this was proposed by Commodity Futures Trading Commission chair Brooksley Born, leaving the Pandora’s box of uncontrolled derivatives trading wide open.
As the 21st century dawned, very few people recognised how perilously perched the banking sector had become. Instead of looking under the hood and probing banks for hidden risks, or asking questions about over-leverage, central bankers, regulators and New Labour ministers preferred to champion ‘light touch, limited touch’ regulation and congratulate themselves for abolishing ‘boom and bust’. Taking its cue from Federal Reserve chairman Alan Greenspan, the UK’s regulatory establishment came to believe that derivatives had eliminated risk, that asset price bubbles didn’t matter, that inflation was their only worry, and that banks’ boards could be trusted to act responsibly. Underlining these dangerous delusions, the Bank of England governor Mervyn King coined the phrase “NICE decade” (non-inflationary constant expansion) in 2003 and Ben Bernanke, then a member of the board of governors of the Federal Reserve, popularised the phrase ‘The Great Moderation’.
The net result of more lax rules and the changed environment was that banks’ balance sheets swelled uncontrollably. As a proportion of GDP, UK bank assets ballooned from 100 per cent in 1975 to more than 450 per cent of GDP in 2014. (Source: Bank of England’s Oliver Bush and Sumuel Knott). This massively increased the earning capacity of top bankers, but also enhanced the risk that the sector could bring down the economy and ‘capture’ the government and political process. In the US, the situation wasn’t quite as bad: total banking assets have grown from 56 percent of GDP in 1950 to 80 per cent today.
We had entered the era of ‘too big to fail’, ‘too big to regulate’, and ‘too big to prosecute’ banks — banks that are so large, governments feel obliged to kowtow to them and rescue them in the event they stumble and fall, fearing that allowing them to fail would devastate the economy. It was around this time — and especially after US President George Bush passed the Sarbanes-Oxley Act in 2002 — that that UK ministers and regulators were touring the world, touting the City of London as the place for financial firms to set up shop, as ‘light touch’ regulation ensured a blind eye would be turned to creative accounting and financial chicanery and bankers would be unlikely to go to jail.
Prime Minister Gordon Brown, who was educated at the same academy in Fife as Adam Smith, had a once-in-a-lifetime chance to transform the banking sector for good when banks started falling like dominoes in September 2007 to October 2008. He could, for example, have attached strings to the £850 billion rescue package, telling the banks that unless they committed to deep structural, behavioural and cultural reforms he was going to let them fail. But the bailouts turned out to be a patch-up job which allowed banks to get back to business as usual, arguably entrenching bad behaviour in the sector. In most banks very little was done to address the toxic, devil-take-the-hindmost, internal cultures that prevailed before 2008, helping sow the seeds of the next crisis.
As Frank Borman, the former NASA astronaut and chairman of now-defunct Eastern Airlines once said, “Capitalism without bankruptcy is like Christianity without hell”.
So, forty-five years since Checkland lavished praise on Scottish banking, with the possible exception of advances in digital banking and mobile apps, the situation has been turned on its head. Branch networks have been decimated, there an absence of personal managerial service Scotland-wide, the banks have received massive subsidies both through the 2008 bailouts and the ongoing ‘implicit’ subsidies — worth an estimated £100 billion a year —which reduce their cost of borrowing and distort market discipline.
Many employees are demoralised and fearful of the future as cost-cutting continue. And rather than being owned and managed by Scots, for Scots, all our banks with the exception of Hampden & Company and Virgin Money (the new name for Clydesdale Bank) are now run from London.
Ian Fraser is a financial journalist and author of Shredded: Inside RBS The Bank That Broke Britain, a fully revised and updated edition of which was published in May 2019.