IT is well known that a major factor in the 2008 financial crisis was the reckless behaviour of banks and senior bank officials, combined with “light touch” regulation, which led to banks continuing to operate beyond sensible capital and liquidity limits.

Basic principles of prudent banking were abandoned in the search for greater market share, mergers, maximum profit and higher share prices.

The necessity for a rigorous and properly enforced regime designed to enforce responsible banking practice is obvious. Scotland should strengthen regulations governing individual behaviour of banking professionals in several ways:

  • Licensing Banks wishing to do business in Scotland will require to obtain a banking licence from the Scottish central bank. Individuals working for banks at senior levels of decision making should also be required to hold a licence to work in banking. An individual’s banking licence should be suspended or revoked if professional standards of conduct are broken.
  • Shareholder duty of stewardship. Bank shareholders must have a duty of responsible stewardship and if they fail to provide proper oversight then revocation of the banking licence will render their shares worthless, as would the alternative of nationalisation of the bank.
  • Personal liability A system of financial penalties should be established so that breaches of professional conduct carry financial consequences. As a matter of principle, incentives need to be aligned to standards of professional conduct. Indemnities by banks for their own personnel should no longer be permitted – if any indemnity is provided it must be by an independent insurer.
  • Professional qualifications All personnel above a given level of seniority must be required to hold professional qualifications of a level commensurate with their level of seniority, responsibility and the size of the bank. Such qualifications should include the inculcation of the principles of stakeholder corporate governance which recognises the interests not only of shareholders but also customers, borrowers, employees, as well as the responsibilities of banks to society as a whole.

One of the biggest responsibilities of a bank is to provide lending to support productive enterprises so that all local and national economies have the capacity to produce all the things people need to live well and in harmony with nature.

While responsibility for financing major infrastructure projects and large businesses may rest mainly with a National Investment Bank and with a National Pension and Investment Fund (or a Sovereign Wealth Fund), private sector banks have capacity to provide lending to the SME sector of the economy to allow small companies to develop and grow.

This is why a large network of small local banks in which lending decisions are made locally is important to support the development of local economies.

At present not enough of commercial bank activities consists of lending to SMEs. Most bank lending is directed at mortgage lending. This needs to change. Lending for housing is important but this should be mainly the preserve of a restored range of building societies.

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Incentivising private banks to lend to businesses can be achieved through the creation of a “credit guidance” framework. What follows is one possible version of such a framework. The numbers used are a matter for discussion and are offered here only as a way to demonstrate how a possible incentive structure works in principle. The incentives are created by a combination of different levels of cap on the interest rates a bank can charge and the level of loan guarantee provided by the central bank. The higher the importance of particular types of lending to the economy, the higher the interest rate permitted together with a higher level of loan guarantee.

  • Tier 1 (loan guarantee of 50% and interest rate cap over the bank base rate of 5%) consists of lending to businesses in the most strategically important sectors of the economy, as derived from an industrial strategy. Mortgage lending by building societies falls into this category as well.
  • Tier 2 (30% guarantee and 4% cap) consists of lending to potentially significant businesses in innovative technologies and products.
  • Tier 3 (10% guarantee and 3% cap) is lending by banks and secured consumer lending (mainly lending for major consumer goods such as cars and important household goods, particularly high-quality goods designed to be long lasting, easily repairable/reusable and recyclable).
  • Tier 4 (0% guarantee and 2% cap) is unsecured consumer lending. High levels of loan guarantee present a risk of “moral hazard” – the temptation to abandon prudent principle of banking in pursuit of high profits whilst the risk of loan default is borne by the central bank.

One of the objectives of the framework for regulation of bankers’ conduct described above is to deter such conduct and uphold professional standards. Loan guarantees should be provided only on the condition of strict adherence to professional standards of banking conduct with severe penalties (up to and including imprisonment) for breaches.