The City Needs a Second Big Bang

Jamie Dimon, head of JP Morgan, has warned the new Chancellor against raising taxes on banks. You would expect him to say this, as he’s a banker. That doesn’t mean he’s wrong.

Banks are an easy target. After the Global Financial Crisis, both Gordon Brown and George Osborne knew it, and built a wall of taxes and rules to make bankers pay for their recklessness. The instinct was understandable. The economics were a mistake.

Economists talk endlessly about Britain’s ‘productivity puzzle’. They’re right to. Productivity is what drives growth, and the standard fix, liberalising planning so it is faster and cheaper to build homes and infrastructure, is correct as far as it goes. But it doesn’t go far enough.

Look at total factor productivity growth rather than the headline numbers and a pattern emerges: manufacturing and financial services have been particularly important contributors to Britain’s post-GFC productivity weakness. Manufacturing’s decline deserves its own article. This one is about finance.

The wall, brick by brick

Since 2008, successive governments have piled taxes and rules onto financial services. Whatever the stated rationale for each measure, the cumulative effect looks punitive rather than economically coherent.

• The Bank Levy (2011) A tax on banks’ balance sheets, designed explicitly to make them pay for the risk they posed to the taxpayer.
• The Bank Corporation Tax Surcharge (2016) Initially an extra 8% on bank profits above an allowance, reduced to 3% from April 2023, on top of standard corporation tax.
• Ring-fencing (2019) Legislated under the Financial Services (Banking Reform) Act 2013 and implemented from 2019, forcing the biggest banks to wall off retail banking from investment banking. An enormously expensive structural overhaul.
• The Senior Managers and Certification Regime (2016) Much greater individual regulatory accountability for senior bankers, plus substantial compliance and documentation requirements.
• Basel III capital and liquidity rules Banks must hold substantially more capital and liquidity, raising the cost of balance-sheet capacity and, particularly during the transition, weighing on lending and lending spreads.
• Stress-testing and reporting Ever-tightening PRA and Bank of England requirements that have become a permanent, expanding cost of doing business.

All of this comes on top of the taxes and rules every firm faces: corporation tax, and the ever-growing list of reporting requirements imposed by quangos such as the Financial Conduct Authority.

Each measure may have had a defensible rationale in isolation. Stacked together, they have reshaped the industry’s incentives. Compliance has become the growth business at the expense of profit-generating activity. Recent moves to simplify parts of the regulatory framework are welcome, but they remain modest against the scale of the regime built since 2008.

The rules that entrenched the incumbents

JP Morgan and Barclays can absorb all this; they have armies of lawyers and compliance experts. It is everyone else who is blocked. Start-ups and challenger banks, the firms that might actually inject some dynamism into UK finance, struggle to clear a regulatory bar that established players spread across thousands of compliance staff.

The rules meant to punish the incumbents have entrenched them.

Britain doesn’t think of finance as a service industry, but that is exactly what it is: the plumbing that lets businesses expand, hire and invest. Financial services still employ more than a million people, but an increasing share of the industry’s resources goes on compliance, reporting and regulatory requirements rather than allocating capital.

Finance was a productive industry in its own right, and efficient intermediation raised productivity everywhere else by directing capital towards businesses able to invest, expand and innovate. Most business operations would not be viable without a financial sector providing the capital they need.

A second Big Bang

Rather than Manchesterism, Burnham and Healey should embrace Thatcherism. It will be unpopular with the public and hated by their own backbenchers, but we need a second ‘Big Bang’ in the City. Abolish the taxes and regulations brought in after the GFC, and abolish the 0.5% stamp duty and the Stamp Duty Reserve Tax on share transactions with them. Banks and financial services firms should be treated like any other industry when it comes to taxes and regulation. That removes much of the burden, freeing them to focus on far more productive activity. It also makes it much easier to set up a new bank or financial services firm, challenging the incumbents and forcing them to up their game by becoming more productive.

Financial services used to drive UK growth. It can again, but not while the tax and regulatory burden keeps climbing. If the Prime Minister and the Chancellor are serious about growth, ruling out new taxes on banks is the bare minimum. The real test of seriousness is whether they are willing to unwind what is already there.