Osborne and the safe size for British banks

Chancellor George Osborne The chancellor will speak at Mansion House tonight

There is a fine line between forcing banks to have enough capital to protect themselves and their depositors against all realistic losses, and setting that capital ratio so high that - in the short term at least - the banks starve the economy of vital credit as they build up their capital.

In a globally competitive market, there is also a question of how far an economy like the UK can force higher capital ratios on its banks than other countries impose on their respective banks, without curbing British banks' global ambitions (although not everyone would agree that those global ambitions are a thoroughly good thing).

All of which explains what some would see as the most significant watering down by the chancellor of the recommendations to reform banks that George Osborne received last year from the Independent Commission on Banking, chaired by Sir John Vickers.

The Vickers Commission, set up the chancellor, recommended that there should be a ratio of 4.06% of pure equity capital to gross loans and investments, as what is known as a "backstop leverage cap", for the biggest banks. By historical standards of what is deemed to be prudent, that leverage backstop is not desperately high. Many would argue that a 5% ratio would be sounder.

In crude terms, it would mean that a bank would have to suffer a 4% fall in the value of all its loans and investments to be wiped out - which hasn't happened that often in history, but is not unthinkable. The losses of Royal Bank of Scotland in the last crisis, over three years or so, would not be a million miles from that.

What is important, however, is that the amount of capital relative to gross assets that Vickers wanted for very big banks was significantly higher than the proposed new internationally agreed leverage backstop, enshrined in the Basel lll rules, of 3%.

Now although the chancellor has implemented most of Vickers' many proposals to strengthen banks, on the leverage ratio he has decided that the UK cannot go beyond the new international norm.

In other words, if the Basel lll leverage ratio remains at 3%, then that is the ratio which will apply to British banks.

The biggest UK banks will be breathing a sigh of relief. Capital is expensive and in relatively short supply. So they were concerned that they would have been significantly constrained if subject to a higher ratio than overseas competitors.

But critics of the banks' sheer size - and there are a few of those around, including the governor of the Bank of England and the chairman of the FSA - will be concerned that British banks will remain dangerously large relative to the size of the economy and the financial resources of the British state.

It is worth reminding you that three banks - HSBC, RBS and Barclays - each have gross loans and investments equivalent to annual British economic output, GDP, or more. Which is why part of what the chancellor calls the British dilemma is how to allow our banks to thrive but not be so huge that when they get into difficulties they risk bankrupting the Exchequer and taxpayers.

To put that into context, British banks in aggregate are well over six times bigger than American banks, relative to the size of their respective economies.

That said, today's banking White Paper from the Treasury, which translates Vickers into firm policy, contains all sorts of other measures to limit the exposure of taxpayers to our banks - such as ring-fencing retail operations, so-called resolution procedures for breaking up banks in a crisis, and forcing banks to hold more debt able to absorb the losses that are generated when things go horribly wrong.

But the leverage backstop is a simple way of reining in banks' excessive ambitions.

In his Mansion House speech tonight, the chancellor is expected to say that his aim is to "protect taxpayers in a way that does not make the UK uncompetitive as a home of global banks" (according to extracts released by the Treasury last night).

He is achieving that, he thinks, partly by tempering Vickers leverage proposal, and also by modifying another of his recommendations - namely by giving an exemption to HSBC, a very international bank, to the stipulation that all its overseas operations should be subject to the same rules as its UK business on how much so-called "loss-absorbing" capital and debt they must hold (see this blog for more on this technical but significant waiver for HSBC).

But there is a risk for the UK in remaining the "home of global banks" (in Mr Osborne's words). And here is one way of thinking about that risk.

In the event that there is a proper banking union in the eurozone, and that the eurozone's crisis subsides - which may seem an absurd idea, but stranger things have happened - international investors would at that point note that the eurozone's banks were in effect insured or guaranteed by the collective resources of all eurozone countries, including mighty Germany. By contrast British banks would only be underwritten by the more limited resources of the UK public sector.

At that moment, the hideous issue of whether British banks remain both too big to fail and too big to save would become a highly relevant one again: it is not utterly impossible that the UK and its huge banks could seem a bigger financial risk than the eurozone.

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

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  • rate this

    Comment number 89.

    The problem is that the Banks 'Head Quartered' in the UK are in fact Transnational
    as are most PLC's
    The problem is Globalised no Govenernment can control them not even
    the USA
    The only hope is prehaps the G20 or some such body, actually being able to do something to achieve united action

  • rate this

    Comment number 88.

    We need to reduce the importance of banking to the British economy, increase the number of smaller banks, and move away from an economy based on buying things we don't need with money we don't have.

  • rate this

    Comment number 87.


    "...what should I do with my savings (mainly cash ISA)?..."


    Why not lend it peer-to-peer?

    You could take a mortgage as security from family or friend, and unlike an annuity, repayment would continue to your estate if anything happened to you.

    The rate would probably be better too.

  • rate this

    Comment number 86.


    "...Don't knock the UK banks - Its one of our strengths !! employing 100's of thousands..."


    The mining and steel industries employed 100,000s too. What's more they actually produced something.

    However, the Tory-friendly media created the impression, that society was telling itself that it was just fine, to destroy all those jobs.

  • rate this

    Comment number 85.

    Don't knock the UK banks - Its one of our strengths !! employing 100's of thousands.

    Obviously the sector needs to be regulated but having a global banks is a very good thing , its interesting in Spain the worst affected banks are the local ones who having 100% Spanish loan books..

  • rate this

    Comment number 84.

    Refreshing to see that thinking peoples have such contempt, disdain, anger and frustration with the Financial Leeches.

    A serious question what should I do with my savings (mainly cash ISA)?

  • rate this

    Comment number 83.

    Our political & central banking elite remain as clueless as the WW1 generals that sent their minions "over the top" with no chance of achieving anything other than continuing the illusion they could win for a bit longer

    This time its our future revenues & services they've sent over the top

    And all to save the previously, still & in future insolvent "banks"

    Contempt not a strong enough word

  • rate this

    Comment number 82.

    #80 CO a huge assumption. And desperate hope.

    The banks have already tanked - they are just trying to keep the debt spinning in the air.

    Nothing we can do short of closing the markets and calling a state of emergency. But we can't even stop them paying themselves ridiculous bonuses.

    They are so esconsed in their fantasy world, their only recourse is to moronically keep doing the same thing.

  • rate this

    Comment number 81.

    @79.Jacques Cartier
    When banks can build capital, they don't want to. And when they want to build their capital, they can't.

    Not quite. Should be

    When banks can build capital, their shareholders don't want to. And when they want to build their capital, their shareholders refuse.

  • rate this

    Comment number 80.

    76.Andy Miller

    "What's the government being doing for the last 9 months with Vickers report?"

    Filed to gather dust. Remember 2019 was the deadline. Expect a flurry of activity around 2018, when they realise it's too late and implement virtually nothing of it but make noises like everything's fine now.

    Assuming the banks don't completely tank by then. A big assumption (or hope?).

  • rate this

    Comment number 79.

    > There is a fine line between forcing banks to have enough
    > capital ... and setting that capital ratio so high that ... the
    > banks starve the economy

    When banks can build capital, they don't want to. And when they want to build their capital, they can't. That's a story of addiction. Bankers are addicted to money and they'll take any risk it.

    Put them all in rehab, for their own good.

  • rate this

    Comment number 78.

    Iceland and the UK have the same problem - the banks that they support are far bigger then the state can bail-out.

    Everyone knows this; even our congenitally blind Band of England Governor (his too big to fail argument & the moral hazard.)

    So what is done - we make our banks even bigger so making it even more difficult to bail them out!

    This is idiocy & will cause progressive banking collapse.

  • rate this

    Comment number 77.

    #74 AuditToday - brain weary from defending the indefensible?

  • rate this

    Comment number 76.

    What's the government being doing for the last 9 months with Vickers report? It does not have view on what services offered makes a bank needy of ring-fencing. It thinks SME lending might be an inclusive factor but has to think about the definition of an SME. Thinks geographic limits are a requirement but does not know what they are. No suggestion as to what legal & operational separation means

  • rate this

    Comment number 75.

    Why can't this fool of a chancellor understand that we need banks that support broadening and growing our economy and nothing else.

  • rate this

    Comment number 74.

    72.enlightened face
    Switch on summer from a slot machine

    67.United Dreamer
    . Plus we need religion to forcefully remind them ...

    Cat Stevens and Sky Fairies on a blog about banking reform

    This whole blog is becoming embarrassing to read
    (hope no one see's me)

  • rate this

    Comment number 73.

    55. Sage Against The Machine
    Yes, the call for monetary reform is definitely gaining momentum.
    You may have seen this, but for anyone else looking for detail here's a link.
    Part III page 25 addresses some misconceptions.

  • Comment number 72.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 71.

    Ring fencing is the only way. And investment bankers can borrow the money like the rest of us. Huge collateral at the ready to underwrite their untreatable gambling habit.

    There's been a remarkable shortage of falling bankers this depression. Not that I advocate this course of action, but its indicative of the guilty getting away with it.

  • rate this

    Comment number 70.

    Fine line between forcing banks to have enough capital & setting capital ratio so high that - even in short term - banks starve economy of vital credit as they build up their capital. Excuse me? Banks are starving economy right now! Banks have been lapping up bailouts to liquidate toxic debt - not to lend to credit-starved businesses. Mostly I see a Govt incapable of seeing the real problem(s).


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