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Banking reform

January 2, 2013

On 21 December, Mark was asked by BBC Radio Four’s World at One programme to comment on the release of a report by the Parliamentary Commission on Banking Standards. The Commission, set up in the wake of the LIBOR scandal, welcomed the government’s proposal for a banking ringfence but concluded that it falls short of what is required when it comes to banking reform. They instead recommend ‘electrification’ of the ringfence which would ensure that a reserve power remains for the full separation of banks’ retail from their investment arms. 

Mark commented:

 I welcome the Commission’s Report as a serious contribution to this ongoing debate. What is most remarkable is that, given we are 4 years after the financial crisis began, there still seems to be precious little consensus about the future landscape of global finance and the financial industry. My one chief criticism of both this report and Vickers’ is that too much focus has been on punishing the banks instead of creating a framework that will help the British economy, and also ensuring our financial and related professional services industry remains globally competitive. There is still this cloud of uncertainty that hangs around the City. I was always wary of the Vickers proposal and the workability of the ring fence proposal – always a risk that it will lose business overseas or the creation of a far more risky secondary banking sector. I am not sure that the electrified ring fence will get round some of those problems. We need to recognise that all banking has some inherent risks – that is the nature of capitalism. We need to move ahead and be aware that having a ring fence situation would put us out on a limb. I think the important thing for the City is that we get some consensus rapidly, let’s move ahead, I hope this will play an important part in getting all of these matters crystallised in the new year.

He also wrote the following article:

The Parliamentary Commission on Banking Standards last month threw the Vickers ringfencing proposals into doubt by recommending reforms that instead call for the formal splitting of British banks’ retail and investment arms – the so-called ‘nuclear option’.

The Chancellor has warned against ‘unpicking the consensus’ on Vickers by resurrecting the notion of a return to Glass-Steagall, the 1930s US legislation which had separated commercial and investment banking until overturned by the Clinton administration in 1999 in the teeth of furious banking sector lobbying.

Yet in truth there has never been any consensus. While the coalition had been under enormous pressure to accept the Vickers recommendations in their entirety, the dispute about their likely effectiveness has never been successfully settled.

Too much of what Vickers proposed appeared designed to punish banks. Surely a more sensible outcome is the creation of a fresh framework serving the interests of both the domestic economy and the UK’s key financial services industry. Nor is it clear that the type of ringfence proposed by Vickers would prevent any future financial crash from placing every bit as prohibitive a burden on the taxpayer as the 2008 meltdown.

The coalition faced an unenviable task in reforming Britain’s banking system, without placing the UK’s vital financial services sector at an internationally competitive disadvantage. Having commissioned Vickers as an independent body, it feels honour-bound to accept its recommendations.

Yet I have long feared the Vickers template was based on an outdated and simplistic division between what amounts to wholesale and retail banking. There are numerous transmission mechanisms between the two that make a hard and fast split between high street and ‘casino’ investment banking difficult to achieve. It is also questionable whether the much-heralded split would make banks better at absorbing losses. A failing investment bank which falls outside the ringfence is still likely to share its name or at least reputational goodwill with the retail bank from which it has been cast asunder. Does anyone seriously believe that there will not also be a run on the retail bank and huge potential liabilities falling back to the taxpayer via the depositors’ compensation scheme?

There was also an absence of any international consensus on how such a ringfence might operate. At EU-level, while the Liikanen Report recommended a similar, Vickers-style ringfence of retail from investment banking, the blueprint was sufficiently different as to heap further uncertainty upon financial services providers here in the City of London. Similarly the Volker proposals in the US failed to replicate the Vickers proposal. As a result, frenetic uncertainty has surrounded the entire regulatory and compliance debate with London-based banks finding it difficult to make plans for the future with confidence.

Fears have also been raised that implementing the Vickers reforms would tie up billions in additional capital and impose upon banks a requirement to overhaul compliance and corporate affairs. Such a burden would be met by the public in higher interest rates and a sharp reduction in the amounts banks are willing to lend. One of the causes of the paralysing strategic uncertainty that over the past four years has enveloped the UK’s banking system is the mixed message from the Treasury and central Bank alike over the dual requirements to recapitalise (and thereby reduce risks of future taxpayer bailouts) whilst being ready to lend to credit-starved UK Plc.

There was always a danger that ringfencing would be sold to the public as a panacea. Today’s well reasoned report should now be a wake-up call imploring the Treasury to look beyond the Vickers recommendations. There must now be a commitment to accelerate the long-stop timing (currently set at 2019) whilst also examining whether a fully fledged breaking up of investment banks from retail banks might prove more practicable and publicly acceptable as well as passing the test of time better than the Vickers ringfence.