The UK banking sector: above a certain size, worse than useless?

Copied from the Treasure Islands blog:

The Financial Times has carried two devastating indictments of UK banking policy in the last few days, which chime closely with our Finance Curse analysis of oversized financial sectors. The first, from its chief economics correspondent Martin Wolf:

"As of August 2013, loans outstanding to UK residents from banks were £2.4tn (160 per cent of GDP). Of this, 34 per cent went to financial institutions, 42.7 per cent went to households, secured on dwellings, and another 10.1 per cent went to real estate and construction. Manufacturing received 1.4 per cent of the total. UK banking is a highly interconnected machine whose principal activity is leveraging up existing property assets.

Why should its expansion promote growth, other than its own? It may instead mainly exacerbate the British economy’s debt-induced fragility."

That is an astonishing set of statistics: even starker than the relevant ones we'd provided in our Finance Curse report. Wolf notes, just as we did, that

"Financial deepening does promote prosperity, but only up to a point. Many high-income countries are beyond it. The huge expansion in finance since 1980 has not brought commensurate economic gains.
. . .
The UK needs to understand the implications of becoming a greater Hong Kong."

And he cites a new paper from the Bank for International Settlements a few weeks ago, updating earlier research,

"by disproportionately benefiting high collateral/low-productivity projects . . the financial sector grows more quickly at the expense of the real economy."

The implications of all this are staggering. The BBC's Robert Peston gives quite a useful summary:

"In the immediate aftermath of the crash and during the subsequent Great Recession, there was a lively debate about whether the UK had become too dependent on the City.
There were two concerns raised: whether it was good for the happiness and cohesion of Britain to be so dependent on an industry where huge disproportionate rewards go to small numbers of individuals, significantly widening the gap between rich and poor; and whether the British economy would be more stable and reliable as a wealth generator if it was less reliant on debt-fuelled growth and more reliant on manufacturing and tradeable services other than finance."

And now, via a new comment article in the Financial Times, by Associate Prof. Dirk Bezemer of the University of Gronigen:

Debt is not all bad; borrowing is good for growth if loans are used productively, so that both the debt and the GDP grow. This is financially sustainable. Problems arise when debt grows beyond the rate of GDP growth. This typically happens because of lending to property and other asset markets, rather than for production of goods and services.

And the data is there to make it crystal clear. He continues, in what is a more optimistic view:

"Banks create debt much as bakers make bread. We cannot reduce our bread consumption and expect all bakers to stay in business. If we want to bring down our debt levels, we cannot avoid shrinking the financial sector.
. . . in the medium term, financial contraction is not an option but the only possible outcome. Banks will run into liquidity problems and lack quality assets.

In other words, he's not just arguing that a shrunken financial sector is necessary, but that it likely. The economy won't support an oversized financial centre forever. That is an optimistic conclusion - unless, of course, your wealth is all tied up in overvalued housing.
None of this analysis is making a 'left wing' argument - concerns about Britain's long term prosperity, fragility and stability are widely shared across the political spectrum. Even so,  this is low-hanging fruit for any forward-looking political party of the Left, in my opinion.

Most bank lending today does not create value-added but volatility and debt burdens.
. . .
Let us face it: banks hinder and hurt the economy more than they help it. Economic growth now requires a shrinking financial sector.

So it astonishes me that Britain's Labour Party, historically the big party on the Left, has not grasped this "Finance Curse" issue and started using it to make life harder for the current coalition government. They express some concern about the City, to be sure, but why no grasping of Wolf's (and our) argument with both hands?

As documented in Treasure Islands, the Labour Party under Tony Blair and even beforehand became utterly captured by the City of London.

It seems that not too much has changed, at least yet.

Update 2014: for more on financial intermediaries see here.