WHAT passes for moderate these days when it comes to banking reform is in fact pretty radical. Yesterday’s interim paper from Sir John Vickers’ Independent Commission on Banking (ICB), if it is implemented, will trigger vast changes to the way UK banks operate – but it reads as a surprisingly sensible and balanced piece of work. There was quite a lot of good stuff in it, especially the measures to try and protect taxpayers and to facilitate orderly wind-downs of failed banks – and also several problems and inconsistencies, some fence-sitting, an occasional lack of precision and other issues.
While the ICB wants Lloyds to sell more branches than the 600 previously agreed, it doesn’t say how many; and it fails to adequately define the boundaries between retail and other kinds of banking, making it hard to quantify what the cost would be of holding more capital against UK retail subsidiaries. Its account of the crisis is way too unidimensional, though that was probably because of the report’s limited remit rather than any genuine lack of understanding.
On balance, however, the ICB’s proposals would make the banking system more resilient, reduce the risk to taxpayers and won’t, on their own, trigger an exodus of large banks from the City. I have to say that this comes as a relief: radical reform of financial regulation is needed, but it needs to be of the right kind. As recently as a few months ago, it looked as if the ICB was going down the wrong route – so it is good news that it isn’t. Its discussion of co-cos, bail-in bonds, the need for bondholders to bear losses and the role of new bankruptcy procedures, including those already agreed in the 2009 Banking Act, are instructive.
But there are some problems. It is absolutely right to want to improve competition in the retail banking market. But not all of its suggestions are sensible. Moving to full bank account portability is a great idea – it has become easier to switch mobile phone provider ever since customers were able to keep their numbers. The same would be true with bank accounts. The ICB is also right that elevated levels of regulation and capital requirements serve as barriers to entry; it is also clear that much of the extra competition before the crisis was actually unsustainable and created by liquidity-rich, high risk forms of lending (such as those practised by Icelandic banks).
However, the idea that new banks could use other firms’ branches, mooted yesterday, would dilute property rights too much. The ICB’s view that Lloyds should sell more branches is short-sighted: no business will ever trust a deal with the British government again. Lloyds TSB had Gordon Brown’s backing to rescue HBOS; it had been explicitly agreed that competition rules would be waived.
The ICB estimates that the implicit subsidy to large banks thanks to the government’s bail-out guarantee is worth more than £10bn a year. There are no cash transfers from taxpayers – but banks can borrow at a cheaper cost and have an incentive to take more risk. The remedy is to create a ring-fenced subsidiary for UK retail operations with more capital and to introduce living wills and specially tailored bankruptcy procedures. In the event of a problem, the government could rescue the retail operation while allowing the rest of the bank to go bust. The ICB wants to increase the amount of capital held by retail banking subsidiaries from seven per cent to 10 per cent. Banks could withstand a five per cent drop in the value of their assets, rather than 3.5 per cent.
But this reform has an unintended consequence: it guarantees even more firmly than before banks’ retail operations. So the implicit subsidy remains, albeit on a smaller scale, and retail units have an incentive to take more risk. This is silly. It would have made sense at least to consider Europe Economics’ Andrew Lilico’s idea that banks could be made to offer special, 100 per cent gilt-backed, fully secure storage accounts in addition to their regular fractional reserve accounts. Consumers would be able to chose to put their savings in either the storage accounts, which would be backed by the state, or in ordinary bank accounts, which would not be.
Crucially, the ICB’s proposals are clearly designed to ensure that banks would not be better off if they moved their HQ abroad. Anybody operating a retail bank in the UK would have to hold more capital, wherever they are based. This report is hardly perfect – but it certainly won’t kill the City.
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