Our September findings are more pertinent than ever
From September 13 2011:
The release of the Vickers report by the Independent Commission on Banking – delivered almost three years to the day after the collapse of Lehman Brothers – brings to mind an old Afghan proverb. “If you think you’re leading and no one is following you,” it says, “then you are only taking a walk.”
So it proved with the ICB, whose report issued Monday 12 September was designed to prevent a recurrence of the darkest days of the 2008 financial crisis, when the British taxpayer was forced to bail out a cabal of wayward high-street banks and their runaway “casino” investment divisions.
“Why would you want to add to your banking system’s pain?”
The ICB was formed in the wake of the 2010 general election by a patched-together coalition government unsure of its footing but determined to be seen to be pro-active. It was the classic compromise solution.
It drew together a hodgepodge group of five individuals, whose constituent expertise includes writing for a financial newspaper, being the dean of an Oxford University college, and a former regulator of the gas industry.
In any other industry – the National Health Service, say – the idea of collating and then acting on information from so few people, some of which had no experience in the industry in question, would have been laughed out of the room.
It drew together a hodgepodge group of five individuals. In any other industry, so few inexperienced people would have been laughed out the room
But banking has, somehow, become “different”. No one wants to go back to the bad old days of casino banking. Britain’sentire economy teetered on the edge in late 2008, when the taxpayer was forced to inject nearly £70bn into a handful of now state-controlled banks, and a further £57bn into the sector as a whole.
Hence the decision to create the ICB. Its report was designed to determine whether British retail lenders should be forced to “ringfence” some of their riskier operations, separating out “retail” and “investment” activities.
Never again would the casino-style activities of investment banking be allowed to taint the more stolid, lending-and-deposit activities of retail divisions. Or so the theory went.
Yet the ICB’s ringfencing report, if anything, was little more than a hedge.
To explain. Our Afghan proverb is on the money. Leadership is nothing if you have no followers, and no one is following London’s example here.
Over the past 15 months, no country has followed Britain’s example – not a single one. There is no emulation of the ICB in Frankfurt or Paris, or in Washington, Dublin, Athens or Lisbon, a few of the cities hit hard by the financial crisis. Beijing and New Delhi meanwhile look on in bafflement, even amusement.
For many, the attitude is this: “We have a raft of new regulations, whether set down by the European Union, or the US House of Representatives. Added to which, there is a host of Basel III regulations to implement. Why would you want to add to your banking system’s pain?”
Ladwa reckons that the process… will cut UK gross domestic product by 0.3 percentage points a year
Analysts concur. Evolution Securities called the report “unwelcome and unhelpful”. Robert Law, co-head of banking research at Nomura in London, describes the ICB report as being “harsher than expected”, and “relatively negative for UK banks”.
Should London businesses fear a credit squeeze?
Added to which, the cost of implementing the ICB’s proposals – costed at between £4bn-£7bn – are “at the high end of [Nomura’s] expectations, representing some 20 per cent of UK banking[‘s annual pre-tax profit].” Banks will thus be forced to continue building up capital as a result, cutting into shareholder returns.
The ICB’s proposals in the Vickers report have other side effects, which, again, will hit London’s banks as well as building societies scattered across the UK.
The report will hinder the revival of the British economy. If more capital is being squirreled away against a rainy day (or another financial crisis) there is, by default, less being used to oil the system.
That means less money available to lend to British manufacturers, services companies, high-technology firms. There is also less capital sloshing around the system to lend to other banks, as well as to the likes of private equity firms and hedge fund specialists scattered across the city.
- Read our round-up of the ICB report
“The report will squeeze credit out the system,” says Manoj Ladwa, a senior trader and chief market strategist at City-based ETX Capital. “The ICB’s proposals give banks more time than expected, with leeway stretched until 2019, so it’s not like the banks don’t have enough time [to get ready].
“But all of this means that there are more bad times ahead for British banks.’” Ladwa reckons that the process of hiving out capital to be stored within ringfenced structures will cut UK gross domestic product by 0.3 percentage points a year.
Putting London at a disadvantage risks the UK economy
Richard Hunter, head of equities at Hargreaves Lansdown, says the move will make UK banks “less attractive to investors”, hitting the likes of Barclays, Lloyds Banking Group and RBS (all of which saw their shares tumble following the report’s release).
Those banks will feel the hit far more than HSBC and Standard Chartered, two lenders based in London, but with huge and growing emerging market profit centres.
The one saving grace, Hunter notes, is the decision to give UK banks four extra years to push through radical, institution-changing reform.
Another key point is the sense that the ICB’s Vickers report is shooting the UK banking industry in the foot. Again, this matters. Britain is, essentially, is a medium-sized, slow-growing economy that boasts one industry with genuinely global clout.
Take out London’s banking sector and Britain, overnight, becomes less than the sum of its parts.
Thus, many are now asking whether British lenders will find themselves unable to compete as effectively in what is, after all, a globalised financial industry.
Peter Hahn, a fellow of City University’s Cass Business School and an adviser to the Financial Services Authority, likens the report to a higher tax on airlines and customers using air travel.
“If you are going to fly trans-Atlantic, or to Asia, and it’s cheaper to fly from France, then that is what you might do,” he says. “So the question here is whether, say, a hedge fund will seek funding from a French bank rather than a British bank, as the [latter] has less capital to utilize.
“Well, yes that might happen. Basel increases regulations and costs for everyone. This report raises costs for just UK banks, so that puts us at a disadvantage.”
It means less capital swilling around within the system. For UK and London companies, this matters.
And, of course, less capital in the system means less available to lend to UK plc. The ICB’s weighty report will demand – subject to governmental approval – that ringfenced banks retain a capital cushion of up to 20 per cent, half of which should be comprised of equity.
A ringfenced operation will in turn have its own board, kept separate from the rest of the lender. The report also suggests that up to a third of Britain’s £6trn in banking assets should be retained inside the fence.
Again, this means less capital swilli
ng around within the system. For UK and indeed London companies, this matters. Britain, unlike Europe, has never been particularly good at banking its small-and medium-sized enterprises. Lenders in the UK see multinationals as their bread-and-butter.
In its report, the ICB pledges to return to an older, gentler world, offering “better-capitalised, less leveraged banking more focused on the needs of savers and borrowers in the domestic economy”. This, says Cass Business School’s Hahn, seems unlikely to happen.
- London business reacts to the ICB report
One fear at least seems, for now, to have been allayed. No bank in the report’s aftermath has rattled any sabers, threatening to move its headquarters away from London, to the likes of Hong Kong (HSBC, StanChart) or New York (Barclays). Other jurisdictions, new-world and old, seem unlikely to benefit from the ICB’s report.
But the entire operation begs the question of what it has really been accomplished here. “There is an awful lot of information in this package but it doesn’t appear to have changed [much],” says Hahn.
The report errs, if anything, toward the more ‘stable’ evolving Swiss regulatory model, forswearing America’s more cavalier offering. Yet that is pretty much it.
Once again we return to our Afghan proverb. The ICB has had 15 months to create its Magnum Opus, a telephone book filled with just as many numbers. It purports to lead – yet no one is following along behind.
Perhaps all these five people wanted to do, after all, was to take us all out for a long walk.
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