With a hat tip to FT Alphaville and their beefier web servers…
Quick take on stability aspects: well trailed moderation (or pusillanimity) in that it preempts radical breakup; tougher capital requirements than Basel III, plus CoCos; leaves liquidity regulation to Basel, and shadow banking regulation to the Financial Stability Board.
The main stability-related points of the report are summarized below.
As trailed, no bank breakup:
Banks must have greater loss-absorbing capacity and/or simpler and safer structures. One policy approach would be structural radicalism – for example to require retail banking and wholesale and investment banking to be in wholly separate firms. Another would be to be laisser-faire about structure and to seek to achieve stability by very high capital requirements across the board. The Commission, however, believes that the most effective approach is likely to be a complementary combination of more moderate measures towards loss-absorbency and structure.
The Commission buys the argument that there is an advantage to universal banking, and that seems to be enough to kick the idea of a full breakup into the long grass:
As to the form that separation might take, a balance must be struck between the benefits to society of making banks safer and the costs that this necessarily entails. Full separation – i.e. into separate entities with restrictions on cross-ownership – might provide the strongest firewall to protect retail banking services from contagion effects of external shocks. But it would lose some benefits of universal banking. On the other hand, it is doubtful that separability of operational systems, though desirable for effective resolvability, would itself be enough.
This is not obviously a good tradeoff. You don’t have to be a radical to see the potential problem:
Under existing arrangements, the big banks make bets using your money – which they profit from if they work and which you pay for if they don’t. “Ring-fencing” allows this to continue precisely because “Chinese walls” break under pressure.
The IBC’s solution relies too much on sophisticated regulation – ignoring the reality that regulators will be out-smarted by better-paid practitioners.
There will always be huge shareholder pressure for universal banks to boost profits at the expense of a sound commercial banking core. And ring-fences are anyway nonsense, as senior executives will have a legal obligation not only to maximize profits, but to know what’s going on across the entire group. That’s why nothing less than total separation will do.
Another of the banking lobby’s myths is that if a “ring-fenced” investment bank gets into trouble, it can fail without harming retail depositors within the same bank. That assumes the ring-fence hasn’t already been circumvented, a deeply unwise assumption, and is anyway not the point.
The point is that, while investment banks are needed to finance all kinds of business activities, their more speculative antics are now carried out on such a scale that they have a serious impact on us when they go wrong.
Perhaps there is more support for the Commission’s view in the meat of the document; in the meantime, the Telegraph makes more sense to me.
What about the political aspects? What will the Lib Dems (junior coalition partners) make of this? Oakeshott, former Treasury Spokesman, might give a clue:
Radical reform of the banks is right at the heart of the coalition agreement and a key reason why Nick Clegg, Vince Cable and the rest of us signed up with the Tories. It’s high noon for the coalition if we bottle out after Vickers’ final report.
Well, it could be that the bottling out’s already happened. So what now for the Lib Dems?
Capital: 10% equity capital; much more than Basel currently proposes, with a layer of (most likely) CoCos too:
On equity capital, an important step is the 7% baseline ratio of equity to risk-weighted assets in the Basel III agreement. The international community is considering augmenting this for systemically important banks. In the Commission’s view, the available evidence and analysis suggests that all such banks should hold equity of at least 10%, together with genuinely loss-absorbent debt. That would strike a better balance between increasing the cost of lending and reducing the frequency and/or impact of financial crises.
The Commission’s view is that the 10% equity baseline should become the international standard for systemically important banks, and that it should apply to large UK retail banking operations in any event. Subject to that safeguard for UK retail banking, and recognising that wholesale and investment banking markets are international, the Commission believes that the capital standards applying to the wholesale and investment banking businesses of UK banks need not exceed international standards provided that those businesses have credible resolution plans (including effective loss-absorbing debt) so that they can fail without risk to the UK taxpayer.
A final comment on regulatory philosophy: a week or two ago I reduced a hardened capital markets trader to helpless laughter by suggesting, not entirely flippantly, that rather than racing to the bottom on light touch regulation, the UK might gain an advantage as a financial centre from visibly tougher regulation. I suppose he is chuckling again now:
An important consideration for the Commission is how reforms to UK banking could affect the competitiveness of UK financial services and the wider economy. The Commission’s current view is that the reforms of the kind contemplated in this Interim Report would support the competitiveness of the economy and would be likely to have a broadly neutral effect on financial services.
First, they would affect a relatively small proportion of the international financial services industry based in the UK. Second, improved financial stability should be good, not bad, for the competitiveness both of the financial and non-financial sectors. The costs and consequences (including for taxation) of financial crises make countries that suffer them less attractive places for international businesses to locate. More resilient banks are therefore central to maintaining London’s position as a leading global financial centre, not a threat to it. So while a further domestic taxpayer guarantee might be to the advantage of some UK banks in international competition, it would be a fiscally risky subsidy without justification. In any case, the location decisions of banks are affected by a wide range of factors that go well beyond the issues that the Commission has been asked to consider.
That’s great but pre-empting the breakup option doesn’t follow through on this perspective as vigorously as one might expect. Right now this looks like more lip service.
More on all of this in a day or two when I’ve had a proper chew.