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Will Regulation W create a UK "Dodd-Frank-Lite"?

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Paul Mason | 12:02 UK time, Friday, 8 April 2011

regulation 2

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.


  • Comment number 1.


    Thanks for the heads up for Monday. Two key questions for the ICB:

    1) Have they considered chopping up Retail Banking in the same way that Telecoms, Gas, Electricity and Rail was broken up? That is separate the network infrastructure for handling payments (as in the Network Rail bit), versus the deposit taking and loan generating activities (as in the train operating companies). The banks profitted from implementing this model on other sectors. How do they feel about the model being applied to their own sector?

    2) Would risk still be mis-priced under this arrangment, and is the tax payer just as exposed? Surely, nothing short of reigning in the practice of securitisation will both remove the mammoth moral hazard present in modern banking, as well as meet Andy Haldane's criteria of "radical reform".

    Dodd-Frank was already a watered down leaky bucket of inneffectiveness. The prospect of Dodd-Frank-Lite is just handing the keys back to Ferris Bueller and his teenage mates.

  • Comment number 2.

    I like the US law that exists in some states that public sector bodies have to do a majority of their business with local firms.

    This generates the small business culuture, allows wealth to be spread amongst local people and keeps out the big boys and girls.

    It is very effective, in particular, in keeping out enormous IT consultancies from gobbling up all the work for mega bucks and then, as is the case so often in the UK, of hiring in foreign workers on third world salaries.

    Can you imagine the benefit for the UK economy if every public sector body had to source their work from such local businesses. Doubt we would have stories, as we had earlier this month in Wales, of a man in a van working for a multinational driving over 100 miles to change a light-bulb.

    I thought that the banks in the US are not legally allowed to work with affiliates but that they just had numerous ways to work around that?

  • Comment number 3.

    Excellent and useful article.
    Yes, I am in agreement with Hawkeye above. This 'feels' very much like a fudge and basically just allows the gaming to continue, with a few minor inconveniences which I guess will be 'managed'.
    The absence of any real strength or stomach within the political system to tackle the clear moral hazard referred to by Hawkeye and the absence of accountability, points to a deep corruption within the political arrangements we enjoy. Unless the risks of financial gaming are removed or separated from the tax payers shoulders, this will all end up with a blood on the floor-but whose blood?

  • Comment number 4.


    The most recent two looked pretty serious to this monetary ignoramus.

    I gather the bad boys were trading tish, which they REFERRED TO as tish, and laughed all the way to the collapsed bank whose collapse they had bet on.

    Why no mention Paul?

  • Comment number 5.

    More like Ken Dodd than Dodd Frank.

    '' In 1989 Ken Dodd was famously charged with Tax Evasion in a very public court case, lasting three weeks, leading to his acquittal.''

    At least we got a few laughs out of Ken.

  • Comment number 6.

    "Apparently he told the Inland Revenue he owed them nothing as he lived near the seaside..."
    Tickle your chuckle muscles, its going to be a nice weekend...have a good one.

  • Comment number 7.

    there is still no legal reason why a handful of people cannot repeat the credit crunch and trash the uk. They are doing it with carbon trading.

    there is no banking reform and there is no break up.

    the number of hedge funds is back up top pre crunch levels. There are asset bubbles.

    what's changed. its 2008 all over again.

    there is still no moral hazard. everyone is betting on Central Banks bailing the economy out. Going long the public purse is very profitable.

  • Comment number 8.

    If there is no full separation of the retail banks from the casinos then this Commission has failed.

    If the big banks remain too big to fail then this Commission has failed.

    If the taxpayer's guarantee is not withdrawn from the casino banks then this Commission has failed.

    If there is any prospect of a repeat of the Crash of 2008 then this Commission has failed.

    The big banks are trying to hold the rest of the country to ransom. They must be broken up as they cannot be trusted.

    Why isn't any of this the main plank of a political party programme?

    For as long as the big banks remain central to the economy of the UK then nothing is safe. Their incompetence and self-interest is proven. It is time to end this injustice.

    If any bank throws its toys out of the pram and quits Britain in a fit of pique and high dudgeon I will be happy to wave them off. I very much doubt if their new home will be quite as relaxed as dear old Blighty.

  • Comment number 9.


    You mean McCavity Brown didn't save the world?

  • Comment number 10.

    They can insert all the caveats they like now they have been bailed out and have all our money. We don't matter, all our politicians are in their back pockets...and always will be as long as they can fix things so they remain forever 'too big to fail'.

  • Comment number 11.

    The banks are not just 'too big to fail', they are too intertwined to fail. They are all exposed to one another, and it looks like they still will be (including crucially the retail arms of the banks) under Regulation W. The banks' exposure to one another's casino arms (as Vince calls them) was what paralysed the banking system when Lehman's collapsed, leading to the credit crunch and recession. Separating a bank's retail arm from its own casino arm won't solve this. Retail banks need to be totally separate institutions that are not allowed to have anything to do with so-called investment banks. Only then will we escape from moral hazard. I know this isn't likely to be the outcome of the current restructuring, and banks would fight it tooth and nail. But we (the ordinary public) should be asking our politicians for safe utility banking for ourselves and businesses so that we can get on with our lives, safe in the knowledge that whatever the next subprime-like fiasco is going to be, we aren't going to take the hit for it.

  • Comment number 12.

    Before any option is preferred it would be wise to think of the real situation likely to arise where there is a financial crisis and the subtleties of subsidiarisation v resolution will be lost on the majority of the banking user population who fearing a collapse will want their money out and safe asap. Regulation W would be just pushed aside in the crisis panic. The real need is for the activities of the too-big-to-fail banks to be supervised not regulated and for the stability and security of the industry to be assured by retaining a substantial element of public ownership. Otherwise it will be just window dressing to save Osborne's and Cable's face. Point two of "Hawkeye" seems to hit the nail on the head. It is as important to control what the banks do as to address what to do if everything goes belly up.

  • Comment number 13.

    I see that Paul Krugman has used the graph on your last posting in reference to his comments on the ECB. I wonder if you saw this from Paul Krugman blog, April 18, 2010, 'Six Doctrines in Search of a Policy Regime':

    "Shadows: I’m very much a Diamond-Dybvig guy – that is, I think of financial crises in terms of the Diamond-Dybvig model of bank runs. The basic idea is that what banks do – what makes them useful – is the way they let investors satisfy their desire for liquid, short-term assets while using most of those investor funds to finance illiquid, long-term projects. The key is the law of large numbers, which lets banks keep only a fraction of deposits in liquid form.
    The problem, as Diamond and Dybvig pointed out, is that such institutions are vulnerable to runs: if something leads investors to fear for the soundness of a bank, they will all try to withdraw their funds – and in so doing can break even a fundamentally solvent institution. The solution, said D&D, was deposit insurance. Of course, this leads to possible problems of moral hazard, so deposit insurance has to be further supported with bank regulation.
    All of this, however, failed to take account of shadow banking – the rise of institutions that were banks in the Diamond-Dybvig sense, engaging in liquidity and maturity transformation, but weren’t classified as banks for regulatory purposes. Hyman Minsky, by the way, saw this coming: he wrote at some length about the rise of what he called “fringe banking”, by which he meant essentially the same thing Paul McCulley of Pimco meant when he coined the phrase shadow banking. And so we recreated the vulnerabilities of the pre-1930s banking system.
    Now here’s the thing: there’s nothing in this story about too big to fail. Indeed, the banks in the Diamond-Dybvig paper are atomistic. And it’s worth remembering both that Lehman wasn’t all that big and that the great banking collapse of 1930-31 began at a Bronx-based bank that was only the 28th-ranked bank in America."

  • Comment number 14.

    The censorship on this site of NN misinformation or of Paul Mason's stance is unforgiveable

  • Comment number 15.

    what we really need is one of these (or similar).

    Funny how it is not on anyones agenda.

    Privatised profits and any loses guaranteed to be socialised by the government...who voted for that anyway.. cant remember that in anyones manifesto.

  • Comment number 16.

    No solution derived from morally-corrupt and politically bankrupt United States models will contain the slightest likelihood of genuine reform aimed at promoting the public weal. The US is the source of the contagion from which we suffer, only it has a far more destructive effect on our society than on theirs because of the sizes of our respective banking systems relative to the rest of our economies.

    The watchword has to be:- "Do whatever the Americans do not do, and you won't go far wrong."

  • Comment number 17.

    Hello all
    I have mentioned before a guy called Hyun Song Shin. He was a financial stability guru of LSE Financial Markets Group and the Bank of England consultant but now resides at Princeton University. I described how he was raising a red flag on the credit boom before all the other johnny-come-lately's. So, I read some of his submission to the Vickers Commission. It's a bit heavy but you should take note of his conclusion. This crisis stemmed from an underpricing of risk in a boom - starkly straightforward. Our famed Tripartite Committee ( guardian of financial stability) were asleep at the wheel believing CPI inflation hitting target, stable output figures and clever City profits were the only game in town.

    Useful now, I suppose, to hear a lot of anti-bank rhetoric from the Threadneedle crew but one wonders whether attack is the best form of defence in this case.

  • Comment number 18.

    When Paul Krugman says that there's nothing in the story about too big to fail and goes on to cite the size of Lehman's as an example he misses the point that 'too big to fail' refers to the size of the bank in terms of the economy. No bank is 'too big to fail' in the sense that all banks can go bust, but once a bank reaches a certain size relative to the economy it exists in the damage caused by said bank going under makes it, almost by default 'too big to fail' and means they will always be able to depend on the good old taxpayer riding to the rescue.

    What the banks will fight against is transparency, if you know where the bad stuff is you can let it go and save the rest. Its not rocket science.
    The opaqueness of the banking system is their cast iron guarantee that the entire risk is always on our shoulders, not theirs. They will fight to preserve that opaqueness.
    We are already passing a massive bill for this mess onto the next generation, the outcome, when the Cabinet Committee on Banking make their decision in the autumn will determine if we're at least making sure the problem won't be coming back to haunt them as well. Why don't I feel confident...?

  • Comment number 19.

    Dodd-Frank Heavey would not work.
    Dodd-Frank Lite would be a joke.
    What is exactly needed is a Glass-Steagall Act, a law that splits commercial and retail banking.
    Why do you think American banks (and apparently UK banks) will not consider a LAW?
    Because anything other than a "law" becomes a game; the game is called beating the system...

  • Comment number 20.

    #18 muggwhump wrote:

    'When Paul Krugman says that there's nothing in the story about too big to fail and goes on to cite the size of Lehman's as an example he misses the point that 'too big to fail' refers to the size of the bank in terms of the economy.'


    Maybe Krugman seeks to deceive on purpose!...he is of course, an anarchist. You won't EVER hear Krugman praise Glass-Steagall.

    Bluesberry is correct...

    'Because anything other than a "law" becomes a game; the game is called beating the system...'

    Post #1 says it all really.

    Don't any of you think it strange that the BBC/Paul Mason do not take a moral stance on this issue?

  • Comment number 21.


    "Maybe Krugman seeks to deceive on purpose!...he is of course, an anarchist"

    Hmmmm ...... I'm sure it's pure coincidence, but this sounds rather like our regular Time-Lord blogger "The Master" (JadedJean, Statist, Tabblenabble_n Burnalllmoney, Voldemort, Sauron ) in yet another reincarnation? But perhaps there are disciples, (or maybe a Bokanovsky process?)

    I am very familiar with Krugman's views, and with anarchist theory and history, and despite my super high IQ, I fail to make the connection. Perhaps I need re-educating?

    Here are Krugman's views on how banks should be regulated. Make your own minds up.

  • Comment number 22.

    Sasha Clarkson

    None of Krugman's links mention Glass-Steagall.


  • Comment number 23.

    I'm not sure how much of this the general public are going to grasp. The pro-cuts agenda is easier to understand than the problems with the banks. But events provide a similar simple message to banks in the experience of Iceland - you can let your failed banks go and survive. I think everyone - with very little effort - can understand that one.

  • Comment number 24.


    At last, James Gordon Brown, hiding McCavity-like in America (lacking the COURAGE to face Parliament) says he didn't understand world money.


  • Comment number 25.

    The idea that it is possible to divorce banks or near-banks from the liability of the nation-state that issues, manages and regulates the currencies they use and the jurisdictions they operate in seems to me to be a non starter, if the banks are multinational, private enterprises that can simply move their activities from one country to another, concealing their true position until they finally hit the buffers.

    I think the only solution is to hold the Sword of Damocles over the heads of the directors and senior management and make them personally liable to a system of strict liability offences that would seem them serving life if they allowed their bank to get into a position to need a bailout and the same threat for any trader in a position to speculate so irresponsibility that this drove the bank over the edge.

    Faced with the very real risk of life imprisonment and confiscation of all personal assets for allowing a bank failure to happen, I'd say that the culture would change quite rapidly - and the first one to go down would scare the bejesus out of the rest.

    Too hard? Unfair?

    Well, think on this.

    If you analyse all crime and boil it down to money, i.e. the compensation/value of each individual crime - an oversimplification I know - then allocated all crime fighting resources according to the sources of our "monetised crime" profile, virtually every single policeman would be in the Square Mile of the City of London, as the majority of crime by value is committed by people and organisations based there, in terms of fraud, tax evasion and other serious offences.

    Virtually no resources would go into shoplifting or burglary - small beer in comparison - violent crime? Again, even if you work out the compensation to the victims, a tiny part of the crime cake too small to bother with.

    Make the punishment fit the crime - your future will be taken from you and your family will be stripped of everything if you allow your bank to be too greedy and take risks that lead to failure and public bailout - finally the "moral hazard" would have some real meaning for those in a position to choose to take these huge risks.

    "Strict liability offences" are rare in law - the only one I remember is if the editor of a newspaper allows the name of a rape victim to be published - the name appears in the paper - the editor goes to jail - case closed. For banking I'd suggest the same approach to a small number of critical issues and key balance sheet requirements.

    If there is no scope for courtroom wriggling and a defined set of offences, the slope from greed to jail would so so steep and slippery that at long last there would be a serious hazard to instil a new morality in banking.

  • Comment number 26.


    Bankers are Barons - cahoots with Governance Barons. Westminster, corrupt cultural centre, anchored by monarchy; self-serving, self-perpetuating; cunningly defended - will not easily yield.

    We are still living within the lie.


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