BANKING REFORM

Yesterday came the publication of the report of the U.K.'s Independent Commission on Banking, headed by Sir John Vickers, a former chief economist at the Bank of England. Although there is lots of other stuff in there, the main proposal is that U.K. banks ring-fence their retail operations (deposit-taking and lending) from their investment banking operations.

It is a measure of how wacky the world of finance became in the noughties that this is widely seen as a very radical proposal. But in many ways it is blindingly obvious. The banking system exists to provide payment mechanisms, and to channel savings (in the form of deposits) into investment (in the form of loans to consumers and businesses). It is - or should be - inherently conservative, since banks have to deal with the fundamental problem that deposits can be (and are) withdrawn on demand, whereas loans cannot be realised so quickly.

Investment banking, on the other hand, doesn't really have anything to do with banking. Its three main elements are consultancy (in the form of advice on mergers and acquisitions, and other forms of finance); broking (in the form of helping companies access the long-term capital markets); and trading (not order-driven trading by their customers, but trading for their own account). The common feature of these activities is that they are not inherently conservative, but very risky. Either risky in terms of obtaining business (companies don't choose to buy another company or issue a Eurobond every day), or in terms of execution (prices can go up or down).

They are however much more exciting than boring traditional banking, particularly if one is working in London and dealing with companies with world-wide operations. Which would you rather do; advise General Electric on a major acquisition and get paid a fortune, or provide an overdraft to a 5-man garage in Sunderland and get a modest salary? Horses for courses, you might say. The problem is that during the noughties, more and more of British banks' capital was being used in the investment banking part of their businesses, with two adverse consequences. With the exception of commercial property, which was viewed as sexy, it was difficult for British companies to get credit (a problem heard a lot today, but one which in fact existed before the financial crisis); and the risk profile of the individual bank got higher and higher. When the crisis struck, it caused massive problems. As my 85-year old mother succinctly pointed out, Lloyds Bank used to be rather a good business until it lost its head and decided after a drinks party at Number 10 that it ought to go and buy HBOS.

Vickers is in effect recommending that the U.K. unwind this nonsense and go back to the time when banking and investment banking were very different and separate things. Not by decree (as the U.S. Glass-Steagal Act did); but through the allocation of capital. In other words, it's OK if you want to do risky things, but those risky things require additional capital requirements, and they should not be allowed to impinge on ordinary banking business.

So far, so good; sorting out structures is a good start. But it is only a start, because it leaves the problem that the flipside of London's world-beating position in international finance is its neglect of its domestic economy. This is not a new problem; there were commissions in both the 1930's and the 1970's to try to address it. Despite that, it remains the case that it is very difficult to change bank in the U.K., it is almost impossible to get a 30-year fixed rate mortgage, current accounts have charges and pay no interest, it is difficult to talk to a human in a bank branch, and many payments are still made by paper cheque rather than electronic transfer. All of these things are different in Denmark, even in my rural bank with seven branches. But that is because my local bank manager is not trying to be a Master of the Universe. Until that changes, U.K. bank reform will remain an uncompleted project.  

Walter Blotscher