Why no bank is too big to fail

Barclays president Bob Diamond: why no bank is too big to fail

The bank's president admits he's made mistakes and his industry has a lot to answer for, but he explains why the world needs bankers

By Kamal Ahmed
Telegraph, 12 Dec 2009

"I may not be happy with the UK at the moment." Bob Diamond stands up from his desk on the second floor of Barclays Capital's headquarters in Canary Wharf and goes to the fridge to get a high-vitamin drink. A smile is playing on his lips. He's joking. Of course he is. Slightly.

It's Wednesday afternoon. Four hours earlier Alistair Darling – born 1953 (Edinburgh, Scotland), lawyer, one-time rumoured supporter of the International Marxist Group – got to his feet in the House of Commons and delivered his pre-Budget report. When it came to the issue of remuneration, Darling said all banking bonuses above £25,000 would face a 50pc "super-tax" levy which the banks would have to pay. That means for every £100,000 bonus agreed by the banks, the banks themselves will be obliged to pay out £150,000 – the 50pc levy, national insurance of 12.8pc and the 40pc income tax paid by the banker.

The next day Goldman Sachs announced that none of its senior executives would be getting a cash bonus this year.

Once upon a time Diamond – born 1951 (Springfield, Massachusetts), moneyman, supporter of the Red Sox – lived in a world pretty much divorced from the world of politics. He got on with running a successful bank. And the Government got on with ... well, whatever it was that governments got on with.

In 2007 Diamond, president of Barclays, earned $42m (£26m). Darling, Cabinet Minister, earned £140,000.

Now their futures are inextricably entwined.

For every inch Darling takes, Diamond has to reconsider the business model for Barclays as a global investment and utility bank that, since the takeover of the collapsed Lehman, plays in the big league – a British bank at the top table with Goldman Sachs and JP Morgan, Standard Chartered and HSBC.

For every inch the regulators take, on capital requirements and stress testing, remuneration and "living wills", Diamond has to reconsider Barclays' position as a UK-domiciled bank.

For every argument Mervyn King, the Governor of the Bank of England, makes about splitting up banks seen as "too big to fail" and introducing "moral hazard" back into the system, Diamond has to reconsider his main arguments for universal banks with a broad range of global services. Every time he is asked about the split of Barclays' investment division from its utility or retail bank, he shoots back the same answer. No, not ever.

Privately he's more worried about the finance sector. Everything is very uncertain at the moment and feels negative. Too right, would be the riposte from the taxpayer, just look at the billions of pounds we've spent shoring you lot up.

The key question for Diamond is what he describes as the "level playing field". How do you ensure, in a world of global capital, that London retains its status as a leading financial centre and Barclays its status as a tier one player? If different countries regulate and tax the financial sector in different ways, banks in some centres will be put at a disadvantage, regulatory arbitrage will ensue, talent will flee and, in this case, the UK will suffer.

"I don't think we have a more important initiative than getting regulatory reform correct," Diamond said.

"I really believe the balance between a safe and sound financial system and economic growth and jobs requires banks that are healthy, strong and willing to take risks. The UK is blessed with three incredibly strong global banks in Barclays, HSBC and Standard Chartered, which have all managed through the crisis and improved their relative positions.

"We in the UK should be proud of that. We all have to recognise that everyone associated with the financial system and financial markets, even those that didn't take direct funding from the Government, benefited from the quick action around fiscal and monetary stimulus from governments and regulators around the world.

"We recognise our obligations because of that and we're all working to get stronger capital ratios, reduce our leverage and increase our buffers of liquidity.

"But I think around capital, around accounting and around human resources and compensation it is very important that the major economies and the major financial centres have a level playing field. The unintended consequences of not doing that are strong. We saw [how] regulatory arbitrage led to real irresponsible behaviour and losses in the past."

At the Whitehead Lecture at Chatham House in London on Wednesday night, Diamond was asked about banks "getting it". Did they get that, now they are underwritten by the taxpayer, their income is an issue? "I am very conscious of the bonus debate," Diamond answered carefully. "It isn't pleasant for my kids to see what people are saying about banking, what people are saying about me."

But, speaking back in his office, he doesn't think that income is the issue. It is surely better, he says, for "strong banks" to be based in the UK paying people and taxes and dividends. The alternative is banks being based somewhere else and paying that money somewhere else. Is London at risk as a financial centre? "There is always a risk," he says.

"Clearly there were mistakes made and I've made mistakes," he said. "This isn't about anyone saying I don't have to be part of the solution. It is quite the opposite, it is about saying I do want to be part of the solution."

He points out the strict governance arrangements he says Barclays has had for many years on remuneration.

"I don't think it's an appropriate question for me to talk about my own bonus.

"I think what is clear is that we quickly adopted the G20 and Financial Security Board principles which are in line with what the FSA and the Treasury were hopeful that the UK banks would do. And clearly that raises deferral levels. So deferrals going from the 24pc level to the 40pc to 60pc level is broadly what's there, and we support those principles.

"We [the whole banking sector] have done a pretty poor job of managing how the process [for bonuses] works. You saw us make some changes to base salaries. We do agree that many functions should have a higher portion of fixed and a lower portion of variable."

Are bankers paid too much for what they do? "I think that is something that the shareholders and the markets have to decide. I don't think it should be a function of regulation.

"If the question is do I understand and am I sensitive to a lot of the emotion, absolutely. I think it has been a very difficult couple of years and we have to balance recognising that there are a lot of people who are angry with banks. Even those like Barclays, who have managed through this very well and who haven't taken direct government money, are still going to be subject to some of the anger, and it is important for our behaviour to represent that.

"But I think the solution to leave the business or shrink the business as opposed to being an even stronger bank is the wrong one. If there were mistakes, let's learn from them. Strong banks are essential."

King spoke of a lack of "moral hazard" in the system, that banks that had a taxpayer-funded safety net will always engage in riskier activity safe in the knowledge that the public purse would pick up the tab. This is the argument at the heart of "too big too fail" and King's position that retail and utility banks should be split.

Although Diamond does not agree with King's solution, he does agree that no bank should be "too big to fail".

"In principle we should not have institutions that are too big to fail or too complex to fail. We need to have a regulatory framework that allows us to address failing institutions.

"Big and systemic are not synonymous and big and failure should not be in the same sentence. We had many small banks in the UK and the US that failed and most of them were the direct result of poor risk management [and] very often huge concentrations of risk by counterparty and by sector.

"We also saw, in the investment banking side, failures such as Merrill Lynch, Lehman Brothers and Bear Stearns, that are no longer standalone investment banks. We saw significant failures during the crisis in narrow banking, narrow investment banking and narrow retail banking. We feel strongly that Barclays and others that have the integrated universal banking model, if we took that away it would add risk to the system.

"Our clients need us to help them with their activities around the world – individuals, companies and governments. If we look at our corporate clients, they manufacture in multiple locations around the world, they sell in multiple locations, they have to hedge currencies, they have to hedge interest rates, they have to raise equity and debt in different locations. There is a real role for a Barclays with those clients."

Last week Mexico announced that it had taken out a $1bn insurance policy against oil prices falling next year – a government hedge to protect revenues from a key commodity. Mexico is the sixth largest oil producer in the world. Barclays Capital, Deutsche Bank, Goldman Sachs and Morgan Stanley arranged the hedge, which followed a successful strategy last year which brought a $5bn revenue stream as prices fell below the $70 a barrel insurance mark they had taken out. That $5bn amounted to 7pc of Mexico's government revenues. Barclays Capital will be the lead bank in arranging Mexico's future hedging strategy.

Diamond thinks it sends a powerful message. "Mexico was able, working with Barclays and Deutsche Bank, to hedge out their forward oil production before the price collapsed. That has not only benefited the economy, it has benefited their credit ratings and their cost of credit, and it has a huge benefit on keeping schools open. There is a real economic purpose for global banks because we have global customers.

"We are the number one provider of capital to the UK Treasury and to the US Treasury. Both of them have significantly higher funding needs right now. They don't have any significant capital and liquidity providers who are domestic. We have to make markets – much of this debt is raised in China, India, Japan, the Middle East, often with currency hedging involved. There is a real economic purpose for the kind of business model that Barclays has."

Number one crops up a lot as Diamond speaks. It was the purchase of the
collapsed Lehman's last year that was "transformational" for Barclays Group, pushing what was once described as a tier two bank into the top league.

"If I think back, the dominance of the US bulge bracket firms globally and in the US was clear, and if ever there was the thought that we could integrate a US bulge bracket broker dealer with Barclays Capital, well, I never thought it could happen. It was only the turmoil of 2007 and 2008 that brought it about. We have today the number one client franchise in the US and the number one client franchise across Europe."

On his whiteboard in his New York office, Diamond has "ONE FIRM" written in big bold letters. Integration is the key. "To be up and running January 1 with one name, the blue colours, blue carpets, the brand completely re-done, the technology re-done, no co-heads anywhere. Investment banking is not well known for strong integration and strong execution, is it? Well, we had an incredible execution."

But what of those who have launched a £7.1bn legal action against Barclays, saying they got the asset at a knock-down price and unfairly benefited from a "windfall profit" when it bought the firm at the height of the financial crisis in September 2008.

"I find it disappointing that the people representing the Lehman estate who benefited from Barclays' actions during the turmoil now use these tactics to claim that something was not as it was.

"We do not think there is any merit to the suit. The deal we did Monday morning was the deal that the judge approved Friday. If we got too good a deal, why did no one else bid? No one else made an inquiry. We announced the bid on Tuesday and it didn't close until Monday morning, so there was ample time for others. I find it difficult to accept they would play this game in public now."

Some analysts are not so sure about Barclays' core strength. Earlier in the year Panmure Gordon suggested that Barclays' exposure to future corporate defaults was of concern. JP Morgan said that Barclays would need an extra £10bn to shore up its capital base to pay for the increased regulatory burden.

Diamond is clear on both. On Panmure Gordon he says: "There was some noise around that which has gone away. We clearly had assets that were stuck which we have been transparent about and reported on. We have reduced those positions by £16bn in the markets and we have taken no economic hits. So, in fact, we have been exiting at the prices that they are marked at. I think that is the best proof we can give and that is why the noise has gone away."

On JP Morgan, Diamond is borderline dismissive. "They are the only analysts who said that. We totally disagree."

A few minutes before his lecture starts at Chatham House, Diamond is sitting in a leather armchair. "Don't you want to say something about how relaxed I look before such an important moment?" he asks. That smile is there again. He tells a joke involving Dubai, the Flintstones, "getting it" and the punchline "Abu Dhabi Does". Everyone laughs.

Diamond is ushered in to the packed auditorium to applause. There is standing room only at the back, people packed in, wondering how this one-time Master of the Universe is going to perform. £6.1bn