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Rachel Reeves, the UK’s embattled chancellor of the exchequer, wishes to raise the country’s rate of economic growth. She is right. As I recently argued, GDP per head is forecast by the IMF to be 33 per cent lower this year than it would have been if the 1990-2007 trend had continued.
Reeves has many ideas on what needs to be done. As she made clear in her Mansion House speech last week, these include deregulation of the financial sector. But the catastrophic outcome of the “light touch” regulation adopted by another Labour government in the years before the great financial crisis (GFC) must not be forgotten. Thus, her new approach needs to be analysed in terms of likely benefits and costs. To do so, we must ask what the aims of deregulating the financial sector are and what the costs are of getting it wrong.
In answer to the first question, a natural and, to many engaged in the financial sector, overriding aim is just to make it bigger. This seems particularly pressing since the sector (which, as the chancellor notes, generates about 10 per cent of GDP) has stagnated since the GFC. But it must not be the supreme aim, because this is, after all, a service sector. Yes, the financial sector employs people and makes an important contribution to exports. But its main aim is to provide a range of services to the rest of the economy, including managing risk and promoting innovation and growth.
Trying to make the sector bigger by encouraging it to take risks that ultimately lead to a devastating financial crisis is the exact opposite of what sensible policymakers would do. Just consider the longer-term impact on fiscal sustainability and economic growth of the GFC. Moreover, we know that decision makers within the industry will never take the full costs of their collective failures into account, because they do not bear them: society as a whole does. This is why what practitioners condemn as “onerous” regulation is essential.
Does the Trump administration understand this? No. That is itself frightening. Particularly in this global context, the UK government must not repeat the mistake of making the financial sector more “competitive” by encouraging excessive risk-taking. That would damage the economy, not help it.
So, does the government’s new approach to regulation make sense? “Up to a point” must be the answer. Reeves said “I am rolling back regulation that has gone too far in seeking to eliminate risk”. Is this accurate? Up to now, it seems to be. But there are dangers ahead in some important areas.
She is, for example, lowering the cost of interventions by the Financial Ombudsman Service, forcing the regulators to cut times for authorisations and approvals and streamlining the “senior managers and certification regime”. None of this seems problematic. Again, proposals to lighten the burdens on challenger banks do not seem risky.
But there is also much pressure from banks to lighten capital requirements and weaken or even eliminate the ringfencing requirements for the domestic operations of the big banks. So far, the chancellor’s proposals in these areas are sensibly modest. But the inclination of banks to argue that the constraints are too onerous, relying on the fact that the crisis happened almost two decades ago, can only get stronger.
This must be resisted. One reason is that it is highly unlikely that bigger banks will be very useful for future UK economic growth. World Bank and IMF data suggests that the ratio of the assets of UK banks to UK GDP is roughly double that of US banks. Do they need to be still bigger? I doubt it.
With the exception of Barclays, the big banks already favour ending the ringfence. But if the goal is to encourage lending to British business, removal of the ringfence around retail deposits would surely have the opposite effect. Finally, the overall leverage ratio of the big banks is around 20 to one. That is high, not low. As Sheila Bair, former chair of the US Federal Deposit Insurance Corporation, has argued, messing about with this would be a mistake.
The banks are not the priority. That, as the chancellor recognises, is to get more risk capital invested into UK businesses, from start-up to maturity. According to Statista, the total capital raised by the venture capital industry in Israel was three times that in the UK in 2024. Increasing that is what truly matters for the UK’s future.
Policymakers must focus not on making the financial sector bigger per se. They must certainly not focus on removing regulatory constraints, regardless. The overriding aim must be to promote a financial sector that drives innovation and growth. This is not what we have. All else is secondary.
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