British Banking: United they stood
BANK bashers will be chipper. Shares in British banks slumped after the release this morning of the final report about the future of the country’s banks by the Independent Commission on Banking (ICB). The main proposal in the report calls for a “ring-fence”—a strict separation between the retail and investment banking operations of the Britain’s biggest banks. It also calls for a significant increase in the amount of capital held within these ring-fenced banks.
Although the proposals’ key elements had been made public in an interim report in April, they appear to have been toughened in important ways. Take the separation. The ICB argues that all retail banking business should be conducted by a separate subsidiary, with independent governance and its own padding of extra capital. This is the part of a bank that regulators see as too important to fail. They hope to reduce the risk of it going bust by insulating it from investment banking while also giving it greater capacity to absorb losses, with a minimum equity capital of 10% with a further 7% to 10% of risk-absorbing capital on top of that.
This could take the form of pure equity, expensive as this is, or of cheaper forms of bail-in debt, such as bonds that convert into equity under certain conditions. Links between the two banks will be watched to ensure that the retail business is not placing all of its money with its parent.
But the report also allows some flexibility. Banks will be able to decide whether some of their businesses, such as banking services for large corporations, be placed within the ring-fenced business. In addition, the “safe” and “dangerous” banks will also be able to share some services and infrastructure. Both proposals seem sensible as they give banks the flexibility to combine corporate banking with retail, if they wish to set aside the extra capital needed for it, while also reducing the potential costs of the reforms.
Investment banking, which in theory would be allowed to fail, will all have to take place outside this fence and will only be subject to international rules on capital. This is the part of banking where British financial institutions would hope to compete globally without hindrance.
The reforms look like a watered-down version of the new Swiss regulations. The Swiss government has also imposed higher capital requirements on its banks. They have to hold 19% in total, but against all of their businesses including their investment banks. Swiss regulators felt there was little public benefit in the country’s two biggest banks having such large balance sheets and felt it safer to simply force them to shrink rather than to risk allowing them to go bust.
The ICB’s proposal may be somewhat optimistic in its hope that the wholesale and other investment banking businesses outside the ring-fence will be allowed to collapse without worries about financial contagion. Yet the ICB has clearly tried to balance its competing interests of making banking safer while still allowing British banks to compete in global capital markets.