This policy wouldn’t have saved Northern Rock or Lehman Bros

THE chancellor’s support for ringfencing the retail sections of banks from their investment arms might have made headlines – but it won’t solve any future banking crises.

Ringfencing wouldn’t have prevented the financial crash, the resulting recession or the bailout of banks by the taxpayer.

Northern Rock and Lehman Brothers were both relatively simple banks, one focused on retail, the other on investment; both would still have failed in exactly the same way under the measures the chancellor has proposed.

It is possible – in certain cases – that the Bank of England as financial regulator might feel in the case of a particular bank that ringfencing could be helpful in making its activities more transparent. But this measure should not be a matter for government legislation and certainly not a blanket approach applied to the whole sector.

Ill-conceived regulation is partly what got the banks in a mess in the first place. The central change banking reform must make is to ensure that banks are able to fail – in much the same way other businesses do, with the appropriate people facing the consequences so that risky behaviour is not encouraged by taxpayer bailouts.

At a time when consumers are feeling the squeeze from rising inflation, regulations that threaten to push up the cost of banking for customers are moving in the wrong direction.

Ultimately banking reform should be about making sure that the people who take the risks bear the costs.

If consumers want the possibility of high returns they need to know their money may not be safe. On the other hand if consumers want caution and are happy to bear the cost of safe banking they should be able to opt for that. Ringfencing is not the structure to deliver this. Allowing orderly collapse is what will enable banks to respond to the demands of different types of customer. Tempting as it may be for the government to further intervene in the structure of banks, it will not make them safer.

The Independent Commission on Banking has been set up to look at how to reform the banking sector. It’s unfortunate to say the least that the Government doesn’t just wait until its final report is published rather than jumping in ahead of time.

Ruth Porter works at the Institute of Economic Affairs

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