The long awaited interim report from the Independent Commission on Banking is out. Sir John Vickers and his wise band of commissioners have sought to resolve a key structural problem in the banking system that was one of the causes of the crisis: that the investment arms of universal banks were able to take large risks with money borrowed cheaply on the back of state-backed retail deposits from the likes of you and me. When the roof fell in it was the taxpayer, rather than other creditors of the banks, who took the hit.
Vickers advocates imposing a ring-fence around retail banking operations and requiring higher minimum capital requirements for this part of banks’ activities. However, above that minimum level the retail arms of universal banks would retain the freedom to transfer capital to the casino division. At the same time, the ICB concludes that there is no need for UK investment banking operations to hold more capital than is required by international agreements. So have these interim proposals done the trick in making banking safer and getting the taxpayer off the hook?
On the investment banking side, the Commission is surely right not to put UK banks at a disadvantage to international competitors, provided they can be allowed to fail without taking the retail operation down with them. That’s quite a big ‘if’. But it’s even less clear that the thinking on the retail side goes far enough.
The reason is that it’s far from certain that these changes remove the implicit taxpayer subsidy to investment banking. While forcibly breaking up universal banks is not intrinsically desirable, it is hard to avoid the conclusion that they continue to exist because they derive commercial advantage from running both current account and casino operations together. In other words, the investment banking operation will want to remain part of a universal bank only to the extent that the latter helps to make the former more profitable.
And, to the extent that it succeeds in doing so, the taxpayer appears still to be providing an implicit subsidy to the investment banking activities. So if the big banks plan to remain universal in the face of these proposals, can the Commission really be said to have got the taxpayer off the hook?
Setting new regulations to effect a de facto – if not a de jure – break-up of the banks that would succeed in doing so would not be cost free, however. Such a move would probably cause the banks to leave for more welcoming regulatory jurisdictions, with attendant costs and loss of City prestige. That might be considered to be a worthwhile bargain for the long-suffering UK taxpayer, but for the fact that the wider UK economy would remain vulnerable to the failure of banks in other, less well regulated, jurisdictions.
So the interim report is a pragmatic response that may improve banking safety but has not banished the problems that led to the crisis. Whether we like it or not, the continuation of some level of implicit subsidy will probably be an inevitable part of the Commission’s final report.
Ian Mulheirn is director of the Social Market Foundation