ZEITtruth…
MILIBAND IS RIGHT TO
CALL FOR THE SEPARATION OF BANKS - IS THAT ENOUGH?
Ed Miliband announced his candidacy for the next General
Election at the Labour Party Conference last Tuesday, with a recrudescent
performance in front of a packed house at Manchester Central.
The details on policy were sketchy and largely absent from
vast swathes of the hour long speech, but in some respects this is
understandable. Miliband spoke for over an hour without using notes, showcasing
a rarely-before-seen jocular style that surprised many detractors.
One policy he did proclaim vociferously – and to a rapturous
reception – was the intention to separate high street banks from “casino style
operations” (investment banks to the less acerbic amongst us).
Separating the high-street and investment arms of banks is
hardly a new idea - with ‘ring-fencing’ of high street banks being
advocated in the Vickers Report in September 2011. Since then, several banks
have begun the process of ‘ring-fencing’ their retail operations, with some
looking to complete this ahead of the scheduled date of 2019 proposed by Vickers
(being the commencement date of Basel III). However, the impact of
rating-agency concerns for the non-ring fenced investment banks – which will no
longer be able to comfort creditors by evidencing a recourse to unsecured
deposits - has predictably lead to a period of lobbying by the banking sector, resulting
in what Labour has described as a watered-down version of ring fencing, where
the fences themselves are allowed to be ‘looser’. But even if – as Miliband
promised a Labour government would deliver – ring-fencing was sufficiently
tightened and legislated upon; will this really be enough to effectively avoid
the catastrophic failure of the finance sector in recent years? Will this
really be enough to ensure that the tax-payer will never again be forced to
pick up the bill for banking profligacy?
So far, neither Labour nor the Coalition have proposed going
beyond the recommendations of the Vickers Report. There have been signals from
the government that any Banking Reform Bill would incorporate recommendations
from the Wheatley Review published last week, which sought to deal with the
rampant criminality exposed during the Libor scandal. Wheatley stressed the
importance of making Libor manipulation a criminal offence and declared that
the BBA should be stripped of their Libor setting role. Wheatley’s gambit
extended little further than the Libor investigation, and with respect to more
systemic reforms in the way investment banks conduct themselves, both the
government and Labour are ominously silent.
To date, ring-fencing the high-street arm of a bank is has
been touted as the most sure-fire way to stave off the need for tax payers to
bail out failed banks in future. It has been suggested that separating retail
and investment banks will make it easier to isolate problems in the event that
a bank fails, with any state-intervention being focussed on the retail
operation where the principal beneficiaries would be ordinary members of the
public.
Ring-fencing the high-street arm of a bank from the
investment side requires the ring-fenced entity to be a separate subsidiary
company. There should be a separate board of directors and the company should
display an operational independence from the non-ring fenced entity, such that
it would be able to list on the London Stock Exchange in its own regard.
Furthermore, transactions entered into between the ring-fenced and
non-ring-fenced entity should be at arms-length. There is no restriction
however on ring-fenced entities receiving funding from its non-ring fenced sibling,
providing that the transaction is at an arms-length.
According to the Vickers Report, the ring-fenced entity
should be subject to a number of restrictions on the kind of service it can
provide to its customers – bringing its activities more into line with those of
a ‘traditional’ high street bank, whose purpose should extend little further
than taking deposits and making loans. It was recommended that there be an
express prohibition on the ring-fenced entity engaging into several types of
‘risky’ transaction, including derivative transactions, or transactions where
the bank’s regulatory capital could be exposed to counter party risk. However,
there is no mention on a restriction or curtailment in this kind of activity
for the non-ring fenced entity. Instead, it is suggested that increased
‘loss-absorption’ requirements (which include a requirement to hold more
capital and ‘bail-in’ bond which would be used in the event of a bank’s
collapse) for non-ring fenced entities will create an incentive to ‘monitor’
risk more closely. But there is nothing in the Vickers Report, nor has anything
been mentioned since by the Coalition or most recently by Labour, which
indicates a move to limit the amount of high-risk transactions the non-ring
fenced entity can enter into – the type of transaction that got us into this
mess in the first place.
The ring-fenced entity, under the Vickers Report
recommendations, is also required to maintain a loss-absorption provision,
equating to between 10 and 17 per cent of risk-weighted assets - depending on
the size of the bank. This is actually not a huge departure from the capital
requirement ratio that Basel II had required all banks to keep; meaning that
the ring-fenced entity can still lend money way beyond the value of deposits it
takes. Yes, it may only lend the money for activities and services that fall
within a stricter remit than the non-ring fenced banks, but there is still an
incentive for it to acquire additional funding beyond its deposit base – though
how it would do so is presently unclear.
Though the ring-fenced bank is prohibited from operating in
the secondary credit and debt markets, there has been no suggestion of a restriction from it
seeking finance in a primary fashion from investment (or non-ring fenced)
banks. This leaves us with a problem, one which resonates throughout the
‘reformed’ system and is yet to be addressed by either Labour or the Coalition.
If the risk-loving and ultimately contagion-inducing activities of investment
arms of banks are left relatively unabated, is it really possible to protect
the ring-fenced sector?
The Vickers Report stated that the banking activities that
would comprise the ring-fenced sector presently account for between a sixth and
a third of the £6 trillion UK banking market; the vast majority of market share is attributed to investment banks. It seems optimistic that merely
securing and safe guarding a diminutive portion of the market will serve as effective mitigation preventing the entire system from collapsing.
Furthermore, if the non-ring fenced system did collapse, it is highly unlikely
that the ring-fenced sector could remain immune to its effects.
Firstly, ring-fenced banks are likely to need funding – and
presently there has been no mention that they will not be able to obtain this
in a primary sense from a non-ring-fenced bank. Therefore, were it to be the
counterparty on a loan with an investment bank typically engaging in ‘risky’
transactions, consumers’ deposits are still subject to a certain amount of
undue risk, albeit once removed.
Additionally, ring-fencing itself, is a complicated and perilous
activity. The Vickers Report recommended that the ring-fenced bank should be a
separate subsidiary company, but there is no mention of how the shares in the
subsidiary should be held. Again, if it is permissible (and to date there has
been little to suggest the contrary) for a non-ring fenced bank to hold a
shareholding in its ring-fenced subsidiary, we are again presented with the
possibility that the depositors of the ring-fenced banks could be exposed to
undue amounts of risk – if the activities of the investment arm are left
unchecked.
The key point in all of this is that unless the risk-loving
propensity of investment banks is not systematically tackled, it will persist;
simply compartmentalising this gluttony for risk will not eradicate the widespread
impact of its consequences. Vickers
suggested that the increased ‘risk-absorption’ requirements put on non-ring
fenced banks would effectively lead to a curtailment in risk taking activity;
but this proposition displays a certain amount of naivety. Investment bankers
and shareholders of investment banks are loath to increases in costs or
reductions in their bonuses and dividends. The increased costs associated with
implementing a greater amount ‘risk absorption’ capital will inevitably lead
traders and bankers to work any available capital even harder; meaning greater
risk will need to be undertaken in order to generate the kind of profits they
had become accustomed to in a ‘pre-reform’ environment.
There has been much talk about the need to create
high-street banks with a different ‘culture’ to their investment counterparts.
But, effectively mitigating against contagion requires a change to the
‘culture’ of investment banks themselves.
A year on from the publication of the Vickers Report – and
following a woeful litany of subsequent scandals – the need for banking reform
is greater than ever. Despite Ed Miliband proclaiming the need to split
high-street from investment banks (and rightly so), there has been no mention
of a detailed attempt to curb the risk-loving activities of the investment
banks themselves. Separating banking arms will simply compartmentalise the
toxicity of high risk, rather than effectively reduce or eradicate it.
Obviously there is an imperative for banks and other investment entities to
engage in risk in order to make a profit, but in the days before the bubble
burst, traders and bankers took on unacceptable levels of risk. If the high-risk transactions that
investment-banks previously engaged in (and presently still do so in a largely
unfettered manner) are left untouched by restriction or regulation - the risk
of contagion still remains. Though a banking separation may cause the retail
banking sector to become one-step removed from its more brazenly-avaricious
sibling, it will never be impervious to the consequences of its licentiousness
- unless such licentiousness is in fact curtailed. The lack of circumspection
on this matter from all parties shows ominous signs for the future and once
again, it could be that ordinary members of the public are left to pay for
myopic policy making.