Will Regulation W create a UK "Dodd-Frank-Lite"?
As I prepare for the Vickers Commission's report into the future of UK banking I am swotting up on "Regulation W". This is a rule in the USA that prevents US banks from doing a substantial amount of business with, and counting on the capital of, "affiliates".
A senior banking source told me they believe the commission will not signal support for any Glass-Steagall type separation of savings and speculative banking.
Instead there will be in indication that Britain could adopt a "Regulation W" type solution.
In the USA this means banks can only do 10% of their total business with any single affiliate; that only 20% of their capital can come from affiliates; and that all loans to affiliates have to be secured. It is, in a way, a remnant of Glass-Steagall that US banks have been whingeing about for some time (because in Europe you can just have universal banks that do everything).
If you combine this with the "living will" approach to bank structures - where they have to state how their complex global structures would be bailed out and broken up in the case of another banking crisis you get a) a clear structure of affiliates and b) a legal limit on the amount of jiggery pokery that can go on between them.
It is not Glass-Stegall but comes close to being the basis for "Dodd-Frank-Lite", ie a forced internal separation of deposits from high risk banking (and to boot it strengthens the claims of depositors over the whole institution should it go belly up).
One of my contacts in the world of financial law has provided the above handy diagram on how Reg W interacts with the mainstream banking regulation on capital adequacy (Reg Y). If I am right, you may be looking at a picture of the future structure of HSBC or Barclays in the UK.
Now, however - a question. Does it meet the test laid down by Bank of England Financial Stability boss Andrew Haldane, two years ago? He wrote:
"Reversing direction will not be easy. It is likely to require a financial sector reform effort every bit as radical as followed the Great Depression. It is an open question whether reform efforts to date, while slowing the swing, can bring about that change of direction."
To me, introducing a regulation that was extant right the way thru the US banking crisis, but failed to stop it, does seem to fall short of the 1930s response.
Short of the absolute legal, cultural and practical separation of deposit taking and investment banks, any set of rules that seeks to govern the internal relationship between the two is open to the kind of gaming we saw in the run up to Lehman. Then, the banks managed to create a whole system of institutions known as shadow banks whose ultimate liabilities and ownership became very misty.
However we'll see what the details are, and the responses, on Monday. One man's Regulation W could, at a stretch, become another man's Dodd-Frank-Lite, especially if the new rules require a "hard restructuring" of banks, with internal demergers, relocations etc.
If they do go for Reg W, it is likely the Treasury will put someone on the Eurostar immediately and suggest to Brussels that this be adopted as a pan-European solution. Eurozone banks don't like the idea, but they are probably going to have to lump it, which is why some of them have been lobbying hard against its inclusion in Monday's report.
Another devil in the detail issue with Reg W is that in the USA it only applies to onshore activities: an American bank in London doesn't have to obey the regulation. So one of the big questions will be whether this does, as warned, drive some UK banks to restructure in a way that puts their main banking business or holding company offshore.
Meanwhile my attention has been drawn to the following paragraph in the Committee's terms of reference.
"The Commission will also have regard to the Government's wider goals of financial stability and creating an efficient, open, robust and diverse banking sector, with specific attention paid to the potential impact of its recommendations on:
Financial stability; Lending to UK consumers and businesses and the pace of economic recovery; Consumer choice; The competitiveness of the UK financial and professional services sectors and the wider UK economy; and risks to the fiscal position of the Government."
Who can be against "having regard to"?
I understand this paragraph was inserted very late, just prior to the announcement of the remit, on the insistence of the UK's banking industry. If you believe Britain's whole economic model, culture and institutions could not survive without the City, then it makes sense to insert these caveats.
However, rightly or wrongly, it is believed in senior banking circles that the above set of caveats effectively allow the Cabinet Committee on Banking to make an economic (ie pace of recovery) and a competitiveness (strength of UK banking sector) judgement to weigh alongside the judgements on financial stability.
In short it could - am not saying it will - provide an economic rationale for avoiding serious bank reform beyond Basel III and what's already proposed.
If so we will be left with the proposed breakup of the high street banks to encourage more competition. That is you will have more choice over what colour of ATM you use and what manner of sales propositions are thrown at you, should you succeed in making your way to the front of the queue in a branch.
My pencil is sharpened for Monday. Even though it's an interim report, it will rule a lot of stuff out, even if it doesn't plump for the final shape of the solution. We'll know by 10.30 am what the parameters of the political debate will be.