With Sir John Vickers releasing his Independent Commission on Banking earlier this month, one question seems to be on everyone’s minds: how will these measures really affect the UK’s markets, economy and businesses?
London is one of the world’s biggest financial centres, and the UK’s economy has a huge reliance on the effectiveness and success of the English banking system.
In his report, Vickers calls for the retail arms of British banks to be ring-fenced from their investment divisions, alongside recommending higher capital requirements for such operations.
In principle, these proposals will create a greater “loss absorbing capacity” within banks, protecting taxpayers from having to pay out billions of pounds in the event of a future financial crisis.
Banks will be required to retain liquid assets totalling 10 per cent of their loan books, as well as a further buffer of seven per cent to 10 per cent in the form of “bail-in bonds”, totalling a safeguard of between 17 per cent and 20 per cent. That figure is significantly higher than anything they’ve held before.
While this may look promising on the surface, in reality there are several issues and potentially disastrous repercussions that the ICB’s recommendations could incite.
The increased capital requirements imposed on banks will prevent them from fully reinvesting returns, thus reducing their profit margins and in turn prompting them to drive up lending costs for UK businesses.
This in itself would have dire consequences. A flourishing SME sector, supported by government initiatives, is what the UK needs to really stimulate growth and strengthen a fragile economy. If banks make it harder and more risky for emerging enterprises to secure funding, the knock on effect would ultimately be a further stagnated British market.
This situation is compounded by the fact that these reforms only apply to banks domiciled in the UK. With foreign players not suffering the same fate, the UK’s competitiveness in the global market will be significantly reduced.
In this way British businesses and banks would both serve to be hit, with the domestic investment sector liable to be struck by ratings downgrades.
To add to this, as the current economic crisis isn’t a problem restricted to the UK, with bailouts already having been granted to Greece, Portugal and Ireland, the implementation of these reforms on British banks alone stands to have little effect on the wider picture.
In terms of the proposed ring-fencing, which aims to protect high-street banks from the riskier activities of their investment arms, as is often the case in the financial sector, the security of the banks will in fact lie largely in the people’s perception of them.
While the retail and investment sections of each bank may be directed to bring in discrete directors, chairmen and boards, they will not be subjected to total separation.
Therefore, with continued operation under the same group name, if a bank’s investment arm suffers great losses, or even collapses, people’s opinions and trust in the organisation cannot be guaranteed – even while the ICB’s reforms ensure that financially the retail side will remain relatively safe.
It is also worth mentioning that it was in fact the retail operations of banks that were at the heart of the 2008 crisis, not their “riskier” investment arms.
Clearly an overhaul of the UK banking system is needed, and the implementation of a firewall to limit damage caused by any future financial crisis may well prove prudent.
The UBS “rogue trader” highlights how dangerous the absence of relevant checks and regulations in financial institutions can be. The key here is to strike a balance between giving banks too much freedom and placing them under overly rigid restrictions.
The fact that these reforms don’t have to be fully adopted until 2019 does give the UK’s financial sector some breathing room, and the economy some time to recover.
In my opinion, however, the stringent rules and recommendations advocated by Sir John Vickers seem very risky in a wider global context.