Glass-Steagall-Vickers

The Independent Commission on Banking in the UK, chaired by Sir John Vickers, former chief economist to the Bank of England, and including the admirable FT commentator Martin Wolf, has just released its report with sweeping proposals for reform. Not quite a Royal Commission, but it was still set up by the government. The report is not another unsolicited paper from a think tank, and can’t simply be ignored.

The aim they state for British banks applies just as well to other countries:

.. a banking system that:
- is much less likely to cause, or succumb to, financial crises and the huge costs they bring;
- is self-reliant, so that the taxpayer is never again on the hook for losses that banks make;
- and is effective and efficient at providing the basic banking services of safeguarding retail deposits, operating secure payments systems, and efficiently channelling savings to productive investments in the economy.

Risk reallocation does not figure as a strategic function.

The key proposal is to ring-fence retail, High Street, banking from investment banking.

Retail banks could be part of larger universal bank groups, but would have separate management, accounts, capital reserves, and culture. They could not engage in trading or derivatives other than hedging the risks arising from retail operations. The fence would be permeable only insofar that lending to big companies would be allowed either side of it.

These proposals (already floated in an interim report) are likely to be very popular in in the UK. Cameron may postpone action on them, but can’t I think reject them outright. Sky TV – a part of the Murdoch empire – called for a first reaction on a campaigner to the left of Vickers. This guy wanted complete separation as in Glass-Steagall.

Does this fix the biggest problem? I’m not sure. It will presumably prevent a rerun of the Northern Rock fiasco, when the government was forced into an emergency nationalization of a big but not systemically dangerous mortgage lender whose wholesale financing had dried up. But the big rescue came later, with the slo-mo collapse of the much bigger and universal Royal Bank of Scotland. Lehman was a specialist investment bank but its failure showed that it had managed to create a systemic risk without any retail banking connection. Vickers seems to rely on global and European regulation of British wholesale and investment banking – which is now at least three times the size of retail in gross terms (Vickers gives the latter’s balance sheets as between £1 trn and £2 trn out of £6 trn.) Another Fred Goodwin could still put British taxpayers on the hook or create a global banking crisis. But at least Vickers, if implemented, will stop such men from siphoning retail deposits into their investment banking casino.

I like Vickers’ robust line on the higher costs which bank lobbyists will plead to frighten the rubes voters:

Our financial stability proposals may increase some banks’ costs of capital and unsecured debt, especially outside the ring-fence. But that is largely a consequence of returning risk-bearing to where it should be – with investors and not taxpayers. This is a benefit, not a cost, to the economy as a whole, and will better discipline risk-taking.

Others of the report’s issues reflect British and not American circumstances. Vickers sees concentration and inadequate competition in High Street banking as a major issue, but not credit card charges. These are reasonably well regulated and bank cards enjoy competition from retail store chains like Tesco. British merchants pay Visa and Mastercard a princely 0.2% interchange fee per transaction after these lost a long battle with the EU competition regulator.

Comments

  1. SamChevre says

    I’m not familiar with the European banking sector, but this seems rather beside the point to the American “shadow bank run”; IIRC, no large deposit-taking institution had to be bailed out. It was all in the wholesale/investment banking sector–Lehman, AIG, money market funds, auction-rate securities; the weaknesses originated in the retail sector (I’d assume residential mortgages are retail), but the much-maligned mortgage securitization system meant that the systematic risks weren’t in the retail system.

  2. says

    One big regulatory problem with universal banking may be that the inter-sector flows of funds and capital allocations are not transparent. When you have a real-estate bubble, where are the original mortgage funds coming from? Northern Rock’s weakness came from its reliance on wholesale funding, which suggests a large flow from wholesale (ultimately the Chinese trade surplus) into retail, rather than a siphoning of domestic retail deposits into the investment side. I assume this happened in the US, given the near-zero personal savings rate. I’m not saying that such flows should be banned; but they should be closely monitored. The 2008 crisis wasn’t triggered by foreign hot money like the SE Asian crisis a decade earlier, but it could have been. The risk is lower for the US than European countries, but it’s still there.

  3. Keith Humphreys says

    James, thanks for this detailed analysis (great choice for a graphic too). It seems to me that if ever there were a reason for G20 to cooperate, this is it. Otherwise individual nations get shaken down by the threat of relocated institutions (or high tax paying individuals) and lose the courage to regulate banks adequately.

  4. says

    Rich individuals can and do relocate. But huge banks? Count me sceptical. HSBC could move its global HQ back to Hong Kong, where it used to be, but would that matter? The concern of the British government is HSBC’s British operations.
    I remember visiting the office of an offshore fund manager once in Jersey. It consisted, literally, of one young man and a secretary. The “Jersey” fund was a legal shell; the back office was in Dublin, the investment team in London. Governments can very easily stop banks doing this flim-flam. Banks have to keep their real management near the centres of economic and political power, since they operate under a set of public licenses and implicit or explicit guarantees, and are embedded in geographically concentrated networks of information and influence. Warren Buffett can operate from Omaha only because he’s a long-term, strategic investor.

  5. liberal says

    I agree w/ SamChevre that any reform that doesn’t address the shadow banking system is (to put it charitably) incomplete.

  6. says

    Sam, liberal: I suggest you look at the report, especially Chapter 4, before rushing to judgement. The Commission recognised the international constraints on standard-setting for wholesale/investment banking, but nevertheless recommended a unilateral strengthening of capital requirements for all UK banking, wholesale and retail, above the Basel III levels. I’m not qualified to judge whether this goes far enough, but it’s certainly a move in the right direction. The current woes in Europe affect large universal French banks, not shadow banking by obscure outfits like AIG.