23-01-2011 banks

There has been little real debate yet in Australia about the changes that may be necessary to ensure that our banks do not fall victim in the future to creating the kind of financial crisis that involved costly bail-outs in other part of the world. In the United Kingdom the attitude of politicians is quite different with the government having established an Independent Commission on Banking to consider the politically difficult question.

The Chairman of the Commission, the former Bank of England economist Sir John Vickers, in a weekend speech has put a carve-up of big UK banks firmly on the agenda. According to the report on The Guardian website, Vickers told his audience today that he wanted to consider “whether, and if so how” structural reforms to the banking industry could work alongside existing plans to bolster bank capital and create “recovery and resolution plans” to cope with crises. He indicated that the new rules from Basel, which could require banks to hold three times as much capital as they presently do, will still not be sufficient to ensure banks hold reserves that can be used as a cushion in the event of collapse.

He ruled out ideas for “narrow” banking – where banks act purely as low-risk, deposit-taking institutions – or other forms of “limited purpose banking”. But he explored the idea that so-called “universal” banks, which combine high street businesses and investment-banking operations, might be required to ring-fence certain riskier operations from their consumer businesses – a process known as “subsidiarisation”.

“Universal banking has the advantage that a sufficiently profitable or well-capitalised investment banking operation may be able to cover losses in retail banking,” said Vickers. “But it has the disadvantage that unsuccessful investment banking may bring down the universal bank, including the retail bank.”

He floated the possibility that the riskier operations of banks could be required to hold more capital rather than being split off from the high street bank completely. But he rejected the characterisation of investment banking operations as “casinos”: “Retail banking necessarily carries risk, notably via exposure to residential and commercial property markets. Thus the popular ‘utility/casino’ distinction between types of banking activity seems more catchy than helpful.”