Financial arms races are scarcely a new phenomenon. How different history might have been had Chuck Prince heeded JP Morgan’s words from a century earlier: “I made a fortune getting out too soon”. Although not new, the liberalisation of financial services over the past 30 years, and the accompanying increase in financial scale, has probably increased arms-race pressures. As banks have piled on the pounds, their fights on the beaches have intensified. The stronger those competitive forces, the quicker an arms race escalates. In what follows, I discuss three examples of modern-day arms races in the financial sector: races in return, races in speed; and races for safety. These are examples from the past, present and future respectively. In each, a competitive battle for relative dominance results in an evolutionary equilibrium which is sub-optimal, individually and socially. They are latter-day tragedies of the financial commons. ************ By any historical metric, the pre-crisis period was an extra-ordinary one for the financial sector. This is no better illustrated than in the returns to financial sector labour and capital. Between 1989 and 2007, the nominal gross value added of UK financial intermediaries rose more than threefold, or by about 8% on average per year. Over the same period, value-added of the non-financial corporate sector rose by about 5½% per year. More commonly-used performance measures in banking are returns on equity and executive compensation. These rose even more dramatically over the period. Returns on equity for UK banks rose from on average 1% in 1989 to 38% by 2007.

32  Haldane (2011), Mehran and Mollineaux (2012). 33  Bank of England (2012), Bank of England (2011b). BIS central bankers’ speeches  9  In finance, these tragedies of the commons are, if anything, more likely than in other fields (seas, beaches and forests). The financial crisis attests to that. If there were a benign, enlightened regulatory planner, able to redirect competitive forces, this could potentially avert future tragedies of the financial commons. Fortunately, there is. References Aikman, D, Haldane, A G and Nelson, B (2010), “Curbing the Credit Cycle”, available at http://www.bankofengland.co.uk/publications/Documents/speeches/2010/speech463.pdf. Angel J, Harris L and Spatt C (2010), “Equity Trading in the 21st Century”, Marshall School of Business working paper. Bank of England (2012), “Record of the interim Financial Policy Committee Meeting, 16 March 2012”, available at http://www.bankofengland.co.uk/publications/ Documents/records/fpc/pdf/2012/record1203.pdf. Bank of England (2011a), “Instruments of Macroprudential Policy – A Discussion Paper”, available at http://www.bankofengland.co.uk/publications/Documents/other/ financialstability/discussionpaper111220.pdf. Bank of England (2011b), “Record of the interim Financial Policy Committee Meeting, 23 November 2011”, available at http://www.bankofengland.co.uk/publications/Documents/ records/fpc/pdf/2011/record1112.pdf. Barclays Capital (2012), “Over Promising? Encumbrance at European Banks”, 8 March. Byatt, A, Fothergill, A and Holmes, M (2001), “The Blue Planet: A Natural History of the Oceans”, British Broadcasting Corporation. Bebchuk, L A and Fried, J M (2003), “Executive Compensation as an Agency Problem”, Journal of Economic Perspectives, Vol. 17(3), pages 71–92. Brunnermeier, M K and Oehmke, M (2010), “The Maturity Rat Race”, National Bureau of Economic Research, Working Paper 16607.