Banking Reforms: Mission Impossible
The report on the UK banking sector issued by the Independent Commission on Banking (ICB) last week has been the source of much debate amongst both political and financial classes. The report, spearheaded by Sir John Vickers, recommends the separation of wholesale banks into retail banks and investment banks by 2014. The implicit aim of the recommendations is to mitigate the risk of taxpayer bailouts (aimed at saving retail banks and guaranteeing people’s bank accounts) by limiting the exposure of the steady, dependable retail bank from its riskier, more volatile investment bank cousin whose activities include trading equities and complex financial derivative products.
So far, the UK press has focused on the circa seven billion pound shortfall which, at least in part, is likely to hit UK bank account holders in the form of additional charges. The flames have been fanned further by claims that a separation of wholesale banks will also hit UK banks’ competitiveness on the world stage. Indeed, I wouldn’t be surprised if figures of Sir John Vickers, the ICB chairman, displace Guy Fawkes on a few bonfires in the richer London boroughs this November.
At the most basic level, the successful separation of investment and retail banks will result in a reduction of ‘cross selling’ opportunities. That is, the ability to efficiently pursue fee earning opportunities from a collective pool of clients. The separation of clients groups will also force banks to brand corporate banking clients (who typically require both basic day-to-day clearing services as well as investment banking services) as either investment banking clients or retail clients. At best, quality of banking services to corporate clients will suffer. At worst, these clients will be lost to international banks operating outside the legislation.
By 2014, UK banks will need to invest significant resources to engineer their best response to the proposed separation. The requirement for retail and investment operations to operate at arm’s length will inevitably lead to the creation of intermediary or agency agreements which will sit just on the right side of the ICB’s legislation but which will effectively allow for communication and cross-selling. Hence the net result will be more legal fees and red tape, neither of which desirable.
Should the legislation stand up to agency agreements between retail and investment banks, the UK banks will seriously need to consider relocating overseas. This will allow them to effectively bypass the new legislation and, once again, compete on level footing with international banks. As we have seen this week, Hong Kong has openly expressed that it will welcome fleeing UK banks with open arms. Tax revenues and the City’s status as a leading financial centre will suffer as a result.
Lastly, empirical evidence suggests that splitting wholesale banks is unlikely to insulate the economy from the financial waves created when the City gets it wrong. The collapse of Lehman Brothers, which operated as a pure investment bank, acts as a good example of this.
Splitting wholesale banks is unlikely to have the desired effect on stability and, given the costs to competitiveness, is probably not worth pursuing at this delicate time. The ruling classes should focus on promoting growth and reducing the national debt burden through traditional measures and not look to tamper with micro legislation which, more often than not, results in red tape, costs and inefficiency.