Ringfencing will not safeguard against future failures
Mixed reactions to Vickers Independent Commission on Banking report into ringfencing banks' retail operations, with some saying it will subsidise bonuses and risks by investment banks and force SMEs to pay higher fees.Ringfencing the retail banking operations from the investment banking arms of UK banks – will it prevent another banking crisis? Well the jury is still out on that, but the UK government is pressing ahead with its separation of banks' operations, but they will not take effect until 2019.
Ringfencing proposals contained within John Vickers' Independent Commission on Banking's (ICB) final report into UK banking, published today (12 September), is expected to cost UK banks between GBP 4 billion to GBP 7 billion to implement. The report calls on banks to ringfence consumer deposits and small business lending from other riskier parts of the bank such as investment banking, but it gives banks the flexibility to decide where the ringfence is applied.
Reaction to the proposals is mixed with some saying other parts of the banks' business – namely private banking – could get caught up in the separation. The British Bankers Association (BBA) issued a short statement, which suggested that the UK government was in danger of implementing proposals, which were not in line with what other countries are proposing. "Any further reform measures adopted by the UK authorities need to be carefully analysed and compared with those agreed internationally," the BBA stated. "It is vital that the full impact any further reforms will have on the economy, the recovery and banks’ ability to support their customers in the UK is understood.”
Michael McKee, head of financial services regulation, DLA Piper, said private banking could get caught up in the ringfencing proposals and that it looked like it would be a "hard" ringfence as the retail bank would have to operate at "arms length", hold a minimum level of 10% capital, as well as a lower leverage limit than international proposals.
Mark Jenkinson, Capco partner, UK banking team, said banks’ governance may require different models depending on the ‘hard’ or ‘soft’ nature of the implementation. Chinese walls for the ‘hard’ option will not suffice, he says, and a full duplication of systems and controls will need to be put in place across both retail and investment entities. "It will only be at the very top of these organisations that retail and investment arms are able to come together," said Jenkinson.
While the Vickers report does not dictate where banks should place their ringfence, Jenkinson says the less arbitrary position will mean different banking models, which will make it harder for regulators to measure ringfenced positions and, more importantly, stop banks exploiting potential loopholes to minimise cost and changes to current operations and governance.
Others believe the proposals miss the point altogether and that banks should be allowed to fail. Mark Littlewood, director general of the Institute of Economic Affairs (IEA), says the proposals do not ensure the orderly failure of banks nor do they prevent such failures. “The idea that bank ringfencing will safeguard banks from failure is a fiction," said Littlewood. "Lehman Brothers was an investment bank without a retail arm, Northern Rock was a retail bank without an investment arm; ringfencing would have had no effect on either.”
Professor, Philip Booth, editorial director of the IEA, says the Financial Services Authority and recent developments at EU level, will deal with bank failures in a much better way than the ICB proposals. "The key to banking reform must be resolution procedures to ensure that failed banks can be wound up," he stated. "The ICB proposals for the general ringfencing of retail and investment banking operations do not contribute to achieving this objective though it would be reasonable to give the Bank of England powers to require ringfencing in a particular bank that did not have a credible resolution plan."
The 2008 financial crisis is often attributed to risky behaviour by the investment banking arms of banks, however, as Booth points out it was failures in both the retail and investment banking sectors that precipitated the crisis. "Artificial separation will not make either the retail or the investment banking sectors safer and we do not want a retail banking sector that is so heavily capitalised that no bank ever fails," said Booth.
In a report written by Ismail Erturk, senior lecturer in banking at Manchester Business School for the New Economy Foundation, Erturk maintains that increased capital for retail operations and ringfencing is more likely to subsidise bonuses and risks at investment banking and will disadvantage standalone investment banks. "Retail customers will shoulder the higher cost of retail operations," he writes. "To achieve shareholder demand for high and unrealistic and unsustainable return on equity, higher capitalised retail banking divisions will charge higher fees and interests to retail customers that include SMEs."
Erturk goes further saying investment banking should be totally separated from retail banking and that it should also be split into traditional investment banking and hedge fund operations where proprietary and risky activities take place. "There should be a regulator for such hedge fund activities that licence each financial innovation only if it is convinced that these are not likely to cause systemic risk and are transparent and unexpected losses as well as statistically-estimated losses can be met by such hedge fund shareholders and managers without any cost to the taxpayers," he writes.
Image provided by Salvatore Vuono.
Date Posted:12th September 2011