United Kingdom
Breaking up the banks comes at a cost - Tim Kirk
Monday’s report published by the Independent Commission on Banking presents recommendations for the greatest reform of financial services for well over 50 years. But no one should claim these reforms would have prevented the banking crisis or that they will prevent another crisis. At best, they make it easier for the banking sector to cope with a future shock – but with a potentially high cost attached.
The Commission’s key recommendations are as follows:
- 1. Ring-fencing: to isolate the banking activities where continuous service provision is vital to the economy and a bank’s customers. This is to ensure that continuation of these activities is not threatened by activities incidental to these, and that they can be maintained without taxpayer support. This is most typically described as separating retail banking from the, so-called, ‘casino banking’ activities of investment banks.
- Loss absorbency: to increase the capital of ring fenced banks so that they are better able to absorb future losses.
- Competition: to require that the business created as a result of the sell-off of Lloyds Banking Group branches can be a strong challenger in the retail bank market with at least a 6% market share. To ease switching, create a centralised, free-for-customers, account redirection service and to improve transparency, banks should be required to provide data on the cost of their services and to provide price information to price comparison websites.
The Commission’s aims are entirely reasonable: stability, transparency and making banks responsible for the risks they take, not taxpayers. But while there is an impressive amount of detail to support its conclusions, the report’s recommendations create increased risks to an already fragile economic recovery and to the international competitiveness of the UK financial services sector.
The Commission’s recommendations are packaged up as a way to protect tax payers from picking up the bill for losses made by risky investment banking activities.
However, the report does not assess how these reforms will affect the ability of banks to continue lending to businesses that are seeking to expand their operations, activity vital to our recovery. It’s already estimated that the impact of global banking reform since 2008 will knock 3.2% off gross domestic product over the next 5 years in the world’s biggest developed markets (Institute of International Finance). The Vickers’ reforms will add to this burden in the UK.
And although the report notes that the proposed ring-fencing is intended to "provide a sound basis for the supply of credit to households and non-financial businesses in the economy", and that the estimated costs could be up to £7bn per year for UK banks, it does not assess the impact these costs and higher capital requirements will have on the banks’ ability to lend to businesses.
Put simply, the reforms will increase costs to banks as they lose the benefit of an implicit taxpayer guarantee. While banks will absorb some of this cost, an element must also be passed on to customers. Business and personal lending will be hit by the ring-fencing, with less funding available at a higher cost. The report also brings closer an end to the free banking we have all become used to.
Despite public and political anger towards banks, they remain a major contributor to the UK economy. By going beyond international minima for capital requirements, the UK becomes a less attractive location for banks who may avoid the UK in favour of more attractive jurisdictions.
While the reforms proposed by Vickers are possibly the best the banks could have hoped for, and reduce the market distortion of a taxpayer guarantee, the wider impacts are unlikely to be universally positive.