Bank reform proposals a small step forward but lack radicalism

Ben Fox gives an in-depth analysis of the Independent Commission on Banking interim report on the future of UK banking.

With more of a whimper than a bang, the interim report of the Independent Commission on Banking (ICB) is out (pdf). There aren’t that many surprises. It pulls few punches about the scale of the impact of the financial crisis on the UK economy, acknowledging that economic output is 4.5 per cent lower than in early 2008 and that unemployment has gone up by 800,000 since the crisis. But the reforms proposed are too ambiguous in terms of how they would work.

That said there are some positive steps. The demand that Lloyd’s group sell off 600 of its high street branches to create more competition is a good one, and a strong critique of the Lloyd’s-HBOS merger, provided that they are bought by smaller or niche market players.

Allowing them to go to another of the ‘big five’ would do nothing to promote competition. The principle of ring-fencing retail arms from investment banking will, by definition, create “living wills” whereby if one part of a bank collapses the rest can survive.

There is no doubt that investment banks should be allowed to fail. They should also keep the capital of their depositors completely separate from the risks they take on financial markets. The recommendation that banks should carry a minimum 10% capital requirement, rather than the 7% in the Basel III rules, is also a good proposal to help prevent over-leveraging.

But the ICB’s “3rd way” between the status quo and full break-up of universal banks providing retail and investment services, is full of pit-falls. Firstly, the ICB hasn’t looked at who decides when a bank is in crisis. Secondly, creating a “firewall” between retail and investment is not as easy or transparent as it sounds. Many banks have services that will deal with both, so they could find ways around the “firewall”.

It is slightly disappointing that the Commission has not considered the full separation of retail banking from wholesale and investment banking more rigorously, which is what the Bank of England governor Mervyn King has called for, but has rejected it in this report on the grounds that the costs would be too high. However, the report does not analyse the costs or benefits from a clear separation of banking activities.

In fact, the report fails to provide any detailed analysis on the costs and benefits of its proposals.

Unfortunately, there is no good news for mutual building societies or financial institutions. There’s actually no mention of them at all, which is a real oversight of a sector that proved its robustness during the crisis. The ICB has been given a very wide remit, and it is a shame that it is not really used it.

There is nothing on remuneration for example. Bonuses, and incentives for reckless investment behaviour in order to get them, fuelled a culture of “casino capitalism” that caused the sub-prime crisis.

Despite the Capital Requirements Directive drafted by Labour MEP Arlene McCarthy, taking the first major steps towards tackling this mentality, the £7 billion bonus-pot that was paid out in January and February shows that remuneration is still well out of synch. With this, as with every other attempt to regulate the financial sector, the banking lobby has attempted to block and delay everything.

So the IBC’s report is a mixed bag. But it’s only an interim report – the Commission’s final report will come out in September. However, the stakes are high.

As Deborah Hargreaves, chair of the High Pay commission, said:

“The total balance sheet of UK banks is more than four times the UK’s annual GDP.

The battle to toughen up these proposals starts now. The director of the Financial Inclusion Centre, Mick McAteer, stated today that there will be a big fight to “implement any truly far-reaching reforms”. But the ICB must be tough enough to resist the banking sector which, led by the British Banking Association, has made it crystal clear that it will not reform itself.

Instead they have made repeated threats that any more regulation will force them to leave the City. The response by the government and the commission will decide whether or not the root causes of the financial sector crisis are tackled or left to be repeated in the future.

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