Eight reasons why British banks do need massive reform


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8:50 am - September 7th 2011

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contribution by Greg Ford

It’s only a week to go before Sir John Vickers publishes the ICB’s final report on bank reform. Predictably, the banking lobby has gone into spin overdrive and is pumping out arguments against change in various newspapers and behind closed doors to government officials.

It is surprising that any politician would want to resist a set of relatively mild bank reforms after the biggest financial crisis for 80 years and a deep recession. The fact that David Cameron is having jitters shows how good the industry is at talking people round.

Here are eight arguments against bank reform culled from the weekend press and eight rebuttals.

Bank argument: Higher equity and ringfencing (or alternatively, the separation of “utility” from “casino” banks), will increase the cost of bank capital and this will hurt the economy.

Rebuttal: Higher equity capital requirements should in fact reduce the aggregate cost of equity and debt funding for banks because it reduces their overall long-term risk (the so-called Modigliani-Miller theorem). In addition, higher equity buffers increase systemic stability, which further reduces risk and bank funding costs.

Banks inside the retail ringfence (or “utility” banks under a full separation scenario) will have an explicit state guarantee and a slightly higher capital requirement, which should make their cost of funding lower than now. This will benefit the economy because most SME lending is done through retail banks.

Banks outside the ringfence (or “casino banks” under full separation) will have a higher cost of capital as their subsidy is removed, but this will have limited impact on the real economy because the majority of investment bank assets are non-productive, meaning they are mostly financial or property-related. This will also help capital to move from the financial into the real economy.

Removing the public subsidy from investment banks through any reform will reduce the chance of a speculative attack on UK government debt if the economy deteriorates, as most economists now predict it will.

Bank argument: UK banks will face a competitive threat as will the future of London.

Rebuttal: The best way to protect London’s long-term future is to improve the stability and function of its banks, not to subordinate these qualities to profitability or short-run returns on equity.

Bank argument: The global economy needs global banks.

Rebuttal: Ringfencing will not prevent banks from offering international corporate banking services. Global corporates managed fine in the stable era of Glass-Steagall and are likely to benefit if ringfencing reduces “financial bundling”, which drives a lot of excess bank profits.

Bank argument: Corporates will move their accounts to foreign banks if ringfencing or separation pushes up lending costs.

Rebuttal: Corporate lending should become cheaper if this relatively uncomplicated activity is left inside the ringfence (or “utility” bank) because it will be expressly guaranteed and better capitalised than now. However, if it is outside (or in a “casino” bank), commercial lenders will need to become more competitive by offering a better service and lowering their own funding costs through safer, higher equity funding.

If banks are unwilling to do this, or they do it but they still lose corporate lending business, that means, by definition, that the business they are losing was only won in the first place because of the UK taxpayer subsidy to bank capital.

Bank argument: Banks will move abroad, eg HSBC to France.

Rebuttal: Democracies do not make policy by blackmail, but if banks want to move they must first find a host country that is free from sovereign exposure, willing to risk its sovereign rating and willing to subsidise the bank’s capital. Good luck to them.

Bank argument: The bulk of UK bank assets are foreign anyway. The UK’s domestic bank sector is no bigger than that of Spain or Norway.

Rebuttal: This is irrelevant. UK taxpayers can be on the hook for the overseas assets of UK domiciled banks just as they are for domestic assets, as we saw with Lloyds/HBOS and RBS.

Bank argument: Ringfencing will destroy the value of taxpayer stakes in RBS and Lloyds.

Rebuttal: It is the long-term value of RBS and Lloyds that matters not their value today, and there is no reason to sell before that recovers. Meanwhile, if these banks are rehabilitated and managed as functional, lending banks without triggering a crisis, they would earn their keep many times over.

The recession has cost the Treasury far more in lost tax revenues than the £35bn that these banks are apparently worth now.

Bank argument: Universal banks are more resilient in a crisis.

Rebuttal: In fact the opposite is true; a universal bank only needs one rogue unit to get into trouble and the entire business can become insolvent. The more units a bank has, the greater the chance that one of these units will get into trouble.

And the bigger the overall bank, the greater the systemic damage if this happens. This is exactly what happened with RBS and AIG. As in many areas, systems made up of lots of different units are generally more resilient than those with fewer, similar units.

—-
Greg Ford is a financial journalist. He covered M&A for nine years until 2008 writing for hedge funds as editor of dealReporter.

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Reader comments


1. AnotherTom

As ever, I don’t understand the link between the headline and the story. These are “reasons why banks’ arguments are wrong”. Whether the arguments suggested are straw men is something I won’t address here.

But surely the main issue with the ICB report is that it’s in addition to, and possibly conflicting with, the raft of new European and global banking regulation that has emerged in recent years. What the politicians are doing – inevitably – is wrapping up banks in tides of overlapping regulations which no-one (other than very highly paid lawyers) will understand. Generals fighting the last war is the phrase that springs to mind.

2. AnotherTom

I will highlight one weirdness in the argument. The claim that: “Bank argument: Banks will move abroad, eg HSBC to France.” appears something of a straw man as HSBC has already said it will move its main centre of operations (back) to Hong Kong because of European banking regulations.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8363584/HSBC-reveals-plans-to-quit-London-for-Hong-Kong.html

3. Tim J

What the politicians are doing – inevitably – is wrapping up banks in tides of overlapping regulations which no-one (other than very highly paid lawyers) will understand.

Probably this is going to be more of a problem in the US (where Dodd Frank is in some areas in actual conflicy with Basel III) than in the UK, where it looks more likely that Vickers, or whatever the reform basis is, will extend Basel III in some areas only.

Perhaps a more pressing problem is that Basel III has already been overtaken by events – its provision that OECD sovereign debt should be treated as risk free tier 1 capital for instance.

4. Luis Enrique

a well-informed post on banking … very refreshing.

although on the “a democracy doesn’t make policy by blackmail” argument – a democracy does, one would hope, make policy by considering the consequences of those policies. Nobody will thank you if a policy leads to bad outcomes, just because you decided not to “give in” to those threatening bad outcomes. But in this case, it’s not obvious banks will move abroad, so point is moot.

5. jungle

“The fact that David Cameron is having jitters shows how good the industry is at talking people round.”

The fact he is having jitters doesn’t demonstrate a lot, because I’m sure he never wanted to regulate any banks, and was only ever posturing for electoral purposes.

The thing is, these rebuttals of anti-regulation arguments are all very valid points; but the banks in practice speak with their wallets, not their words. Ultimately their influence over the government and policy (and the opposition, although since they’re out of power with no election approaching they’re semi-immune at the moment) comes in campaign donations and issuing economic threats, not winning any logical arguments.

6. Greg Ford

@AnotherTom – I don’t llike international overlap and excessive regulation either but it’s a messy world. The main point of the article is that a lot of the opposition to bank reform – including simplifying regulations – is based on deeply flawed public interest arguments, private interest masquerading as the common good. If we cannot debunk these, then we have no chance of an honest discussion about our financial and economic problems that gives the right amount of weight to bank’s legitimate private interests but no more.

On the straw men comment, all of these arguments come directly from the BBA and have appeared in some of the more unquestioning parts of the national press.

On HSBC and HK – curious to see how the Chinese Communist Party will treat board members in the event of a bail out. I somehow doubt they’ll be enjoying Fred the Shred pensions

@TimJ – agree, this is a massive problem that nobody is addressing, or even really talking about yet. Basel (incl Basel III) makes productive SME lending too expensive so we have a worse recession, and sovereign/AAA sub-prime etc lending too cheap, so we have crises. It has a lot to answer for

7. AnotherTom

@3 @6 I find it curious that there’s a big media event about the ICB whereas it’s pretty clear that it’ll have only a minor effect on banks (maybe to send HSBC out of Europe, maybe Barclays also). I guess it gives people an opportunity to chat about how much they hate banks! (Did you hear Radio 4′s Any Questions last week?!)

8. AnotherTom

@6 if you want to respond to national media stories then good luck! they tend to know b*gger all about finance.


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