The dangers of a retail ring-fence

 

Robert Peston explains what this will mean for the banks

It represents the most significant reform to our banking system since Big Bang in 1986 made it much easier for our giant banks to buy stockbrokers and become huge in investment banking.

The ring-fencing of our giant banks retail operations, which the chancellor is announcing tonight, will mean that the parts of Barclays, HSBC and Royal Bank of Scotland that look after our savings, make loans and move money around the economy will be insulated from their investment banking and securities trading businesses.

The idea is that retail banking will have more of its own capital to absorb potential losses. And, in the worst case of a major crisis - of the sort we experienced in 2007-8 - a retail bank could be hived off and saved by the Bank of England, at less cost to taxpayers, because the investment banking part of the same bank would be allowed to fail.

The idea is not to make it impossible for banks to collapse - but to prevent their failures putting an unsustainable burden on taxpayers and the wider economy.

Some bankers, such as Royal Bank of Scotland's chief executive, Stephen Hester, have raised doubts about whether the reform really will make the banking system less dangerous for us - and he has warned that the cost of banking could rise, potentially to the detriment of customers.

Meanwhile for those campaigning for the formal break-up of the mega-banks, George Osborne isn't going far enough.

However it is almost impossible to assess the proposal, because the Treasury isn't ready to give detail about precisely which parts of a universal bank would be inside the retail ring fence.

A recent suggestion by HSBC - which would base the break-up on a new accounting standard differentiating a bank's trading activities from traditional banking (in the jargon, those assets valued on an accrual basis would be in the ring-fenced retail bank, and those marked to market would be outside) - would see some 60% or 70% of a bank inside the ring-fence.

Now some bankers argue that HSBC's proposal would tend to keep taxpayers far too exposed to potential bank losses - since, in practice during the recent crash and recession, losses for banks on HSBC's definition of retail banking have been massively greater than investment banking losses (by a multiple). For example, HBOS's insanely loss-making loans to property businesses would have been inside the ring fence, on HSBC's definition.

Or to put it another way, many would argue that it would be a public policy failure for taxpayers to give an explicit guarantee against failure for the vast majority of banks' activities. That could encourage banks to take even more reckless risks.

So the challenge is to make sure that only the bits of retail banking that are absolutely vital to the proper functioning of the economy are protected and inside this financial cordon sanitaire.

 
Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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  • rate this
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    Comment number 38.

    Finally I would add that the bond markets, commodity markets, currency markets and equity markets all functioned remarkably well during the crisis and yet are all now tarred with the same brush, as far as additional regulation, as the credit markets that caused the problem.

  • rate this
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    Comment number 37.

    ... or as Peston rightly argues

    "in practice during the recent crash and recession, losses for banks on HSBC's definition of retail banking have been massively greater than investment banking losses (by a multiple)."

    The investment side, with some exceptions, survived better than the lending side and are not really part of the problem yet have been reviled by the ignorance of politicians.

  • rate this
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    Comment number 36.

    I remember when retail banks bought broker firms in 86 that a number of my colleague brokers told me what a disaster it would be as banks had no idea of the City and focussed on 90-day profits not 18-month investment cycles.

    The irony though is that it was not investment errors that crashed the banks but their failure to manage the underlying credit business that they were first founded upon.

  • rate this
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    Comment number 35.

    I said it once and I will say it again: ring-fencing is not good enough. The wizard accountants at huge investment banks can crawl under, over, or around ring-fencing. These huge investment banks must be split entirely from retail banking.
    This is a gate that must be padlocked before the horse escapes; in fact, take the horse and hide it.

  • rate this
    +1

    Comment number 34.

    I would prefer a clear mechanism to wound up failing banks in an orderly manner, Enables shareholders to have more control over management and have mechanism of raising capital requirements vis a vis level of risk assets. Regulation was one of the principal failure and I cant see how BoE can offer a better option without a clear living will process. Fear will not make us better but brevity!

 

Comments 5 of 38

 

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