Having bailed out a handful of banks in the past couple of years, the British government set up the Independent Commission on Banking (ICB) in 2010 to come up with a set of reforms to make the banking sector more stable. The commission, chaired by Sir John Vickers, aims to put an end to the “we’re too big to fail” cliche by banks.
So after a year of wearing their thinking caps, what have the chaps at the ICB come up with?
The commission’s interim proposal cites that there is a need to hike the minimum capital requirements from the current level of 7% level to 10%, so that banks would have a bigger cushion against losses.
On top of that, Sir Vickers and his crew thought that it would be a good idea for British banks to ring-fence their retail arms from their investment-banking divisions.
In geek lingo, ring-fencing refers to the act of creating separate entities within a corporation.
What the ICB wants to happen is to keep the retail banking division, which covers consumer deposits and small business loans, safe from the risks posted by the speculative nature of investment banking.
If the government approves the proposal, it basically pinky swears that it will support retail banks and their depositors – no matter what! On the contrary, investment banks won’t have government bailouts to rely to when they are on verge of going bust.
Chancellor of the Exchequer George Osborne, who is in charge of the U.K.‘s fiscal and economic affairs, seemed pretty impressed with the report. In fact, he already endorsed the ICB’s proposal earlier this week even when the report still wasn’t done!
Sure Sir Osborne, the idea sounds good… in theory.
Naysayers are skeptical if the economic implications of ring-fencing are indeed sound. You see, some are saying that perhaps the only reason why the Chancellor was so eager to approve the proposal is because he wants to show that the government still has ideas on financial reforms up its sleeve.
One of the disadvantages posted by the ICB’s proposal is that London would sacrifice its reputation as a financial capital. More stringent rules would probably give finance and business junkies more reasons to move to other economically-influential cities such as New York.
There is also some doubt if ring-fencing would effectively reduce the risks of another banking crisis. Reviewing the books of Anglo Irish and HBOS (two banks that were bailed out by the government), excessive commercial property lending was as big of a problem as risky investment-banking.
Lastly, the move would also post a moral hazard. Think about it. Bankers know that the government would bail out retail banks when the situation calls for it. How long do you think would it take for them to find a way to abuse the government’s promise?
The ICB’s final report isn’t due until September and if you ask me, the uncertainty surrounding the idea would probably be bearish for the pound. Heck! We still don’t know what the scope of the fence would be!
Earlier this week we heard Moody’s holler out a another credit warning downgrade to the U.K., saying that the move would be negative to the country’s credit grade. Hotshots at the ratings agency think that investments of existing bondholders won’t be supported by the government when it makes ring-fencing official. Yikes!
Then again, we have to give Sir Vickers and his chaps some props for not coming up with just another band-aid solution. But the question is, will ring-fencing work?