Banks and bad competition

"I may like many bankers, but I rather dislike banks. I recognise their necessity, but fear their irresponsibility." So spoke one of Britain's leading economic commentators in January.

Now another of Britain's leading economic commentators, Will Hutton, has just said this:

"It is true that competition tends to deliver efficiency and generalised economic benefits. But competition between banks is different. The reason is that, unlike other industries, the soundness of what any one bank or building society does depends on the behaviour of all the others. If they all compete to lend aggressively without any regulatory constraint, that provides home-buyers the plentiful mortgages to buy homes whose prices go up. That in turn makes the original collateral even sounder. Thus emboldened, banks lend again and again. The result is a credit boom and asset price bubble that no power on earth, except prohibitively high interest rates, can keep in check. Unfortunately, the same works in reverse."

This is somewhat analogous to our own arguments about tax competition: people who believe that "all competition is good" fail to see that there is good competition - such as competition between suppliers in clean and properly regulated markets, and bad competition - like competition between companies on who can pay the biggest bribe to win a contract. Banks, as Hutton points out, engage in bad competition in this respect.