How PPI profits hid a cost problem - Editor's Blog -

Focusing on income and ignoring costs will always bring trouble in the end, as the PPI scandal in the UK revealed, writes Brian Caplen.

What is the connection between the UK’s payment protection insurance (PPI) mis-selling scandal and the more general challenge for banks, and indeed whole economies, to raise their productivity? In a previous blog I argued that regulators and company boards are asleep at the wheel if they are not asking searching questions about banking businesses that generate huge profits and seem too good to be true. As in the case of PPI, and subprime mortgages in the US, the reality is that they turn out to be highly flawed as products and end up causing both the banks and the economy huge damage in the long run.  

But a board that had asked really searching questions about PPI would have discovered something even more profound. Why were banks so in love with the profits from PPI? Because it enabled them to put off the tough cost-cutting decisions that were long overdue but would have involved the politically charged, and unpopular, reality of large-scale redundancies. Easier, then, to find a bogus income generator and ignore the cost dimension of banking’s mainstay cost-to-income ratio. Only now, with banking income under pressure and interest rates on the floor, are banks addressing the cost issues that should have been tackled long ago.  

What is true for banks is also true (and remains true) for the UK economy. Prior to the financial crisis, successive governments became addicted to the tax revenues from the country’s outsized financial industry and so were not incentivised to be pushing investment into cutting-edge technologies.

Indeed the use of quantitative easing as a way of avoiding a depression has had the effect of keeping many zombie companies afloat with cheap debt long after they should have failed. British companies have preferred to take advantage of a combination of cheap migrant labour and liberal employment laws to keep themselves profitable rather than investing in new technology. As a result, UK productivity has lagged behind that of other advanced economies.

But just as with PPI, this approach to economic health is ultimately unsustainable and the tough restructuring decisions for UK industry will eventually have to be taken. Depressingly, all discussion about the biggest issue facing the UK – and the solution eventually to the grievances that inspired the Brexit vote – have been supplanted by the total immersion of the political classes in the debate about Brexit.Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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