The price and perils of taking on the banks

Poring over the minutiae of the British banking sector is not everyone’s idea of fun, but Sir John Vickers and his colleagues on the UK’s Independent Banking Commission have spent the past year doing just that. The work will have been intricate and those involved deserve some sympathy. For as things stand, next week’s report, despite presumably offering rigorous analysis and some imaginative proposals, looks like striking only a glancing blow for financial stability.

There are three factors behind this disappointing prospect. First, some powerful economic crosswinds have buffeted the commission. Second, the UK’s powerful banking lobby has made the most of these crosswinds. Third, the British government’s unexpectedly bold initiative in setting up the commission has not struck a chord overseas, greatly weakening its scope and influence.

The economy is the backdrop. The outlook has deteriorated since the coalition government announced in June 2010 that it would set up the commission. At the time, no one expected a picnic but since then whenever an economic or corporate indicator has changed, it has been for the worse. This has made governments in Britain and elsewhere less willing to take risks, leaving the commission pitching its proposals into risk-averse waters. Consequently it toned down its more radical thoughts ahead of last April’s interim report, on the basis that there was no point in losing goodwill in Westminster and Whitehall with politically unacceptable proposals.

The banking lobby has seized upon the economic environment to bolster its case for caution. Like yapping dogs in the night, the British Bankers’ Association and the Confederation of British Industry have formed an unrelenting chorus on the commission’s deliberations. The lobbyists are right to say that credit flow is essential to get the economy running again. But they have never satisfactorily explained why ringfencing retail banking might choke off the supply of credit to small and medium-sized enterprises most in need of it. Yet the noise they have created appears to have put Vickers on the back foot, causing it to use energy and time in deflecting spurious arguments.

Meanwhile the banks themselves played a subtler game. At times they have appeared like Janus, the two-faced Roman god capable of looking both ways. Take Barclays, for example, with one face paying homage to the bank’s 300-year-old history in the City and the other making veiled threats to relocate to New York should British regulations make it uncompetitive. It has been an unedifying spectacle.

However, their arguments highlight the difficulties facing a nationally based commission such as Vickers’. Two years ago, when I urged the then prime minister to commission an over-arching independent review of banking, it appeared that there was global interest in structural change; now there is almost none. For whereas other governments, central banks and regulators, like the UK, are introducing capital and liquidity rules for financial institutions, the UK is virtually alone in contemplating structural change. Worse still for structural reformers, integrated universal banks are so embedded in continental Europe that breaking them up would cause too much upheaval even to contemplate change at this fragile moment. In the US, Congress thinks it has done enough by banning investment banks from proprietary trading and calls to split commercial and investment banking have died down.

International disinterest in structural banking reform means that when the Vickers commissioners considered breaking up the integrated banking model in Britain, their options were limited. They needed to ensure that their proposals would not hobble

globally ambitious British banks or make the UK an unattractive place for others to do banking business. As such, their ideas to ringfence retail and investment banking are about as far as they could go, but let us be realistic. This is not Glass Steagall, with which in 1933 US legislators set the tone for three-quarters of a century of largely safe banking by forcing apart commercial and investment banking. The Vickers ringfence is a measure limited in scope to British jurisdiction. It might help for an orderly wind down in the event of a big bank failing in Britain but on its own adds little to global financial stability.

There is, however, a greater prize that could come out of the Vickers commission. The interim report has already broken new ground by showing that mitigation of the “too big to fail” problem is perfectly feasible and the final version has the potential to become a blueprint for global banking reform. Whether it fulfils this potential or it joins the many banking reports gathering dust on the shelves depends partly on the ability of the government, central bankers and regulators to build a global consensus behind the idea that functional separation in banking is desirable and achievable. It also requires the Vickers commission to hold its nerve in the last days of negotiation, and for the government to accept its recommendations and then pass watertight legislation with a realistic timetable. The serious lobbying is about to begin.

The writer is a visiting fellow at the Institute of Historical Research. 

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