Hester: Bank ring-fence 'may increase risk'

RBS chief executive Stephen Hester giving evidence to the Banking Standards Committee Mr Hester said it was the type of banks that would fall inside the ring-fence that have typically collapsed

The new banking ring-fence may raise the risk of banks needing to be rescued in future, the head of RBS has warned.

Stephen Hester told MPs the tendency to assume that business inside the ring-fence was government-guaranteed and "safe" might encourage risky behaviour.

The ring-fence is designed to separate a bank's core activities from its riskier investment banking business.

The RBS boss was addressing the Banking Standards Committee alongside the heads of Lloyds and Standard Chartered.

The ring-fence, which was recommended by the Independent Commission on Banking headed by economist Sir John Vickers, would require banks to put their High Street banking operations into a strictly separated subsidiary, and is expected to be implemented by 2019.

'Simple banks'

"The language of ring-fencing has a huge risk of moral hazard," Mr Hester told the committee MPs, saying that it created the wrong impression that ring-fenced entities were so important that they could not be allowed to fail.

Moral hazard is a concept developed by economists and refers to a situation where an entity such as a bank expects to be rescued if it gets into trouble and therefore has an incentive to take bigger risks in the hope of making bigger profits.

Mr Hester said the main priority of legislators and regulators should now be the question of "bailing in" - the need to ensure that it is the bank's lenders who take the losses when it gets into trouble, not taxpayers.

Start Quote

[Banks] too often saw customers as being somebody from whom to make money”

End Quote Stephen Hester RBS chief executive

The Royal Bank of Scotland chief executive claimed that it was wrong to assume that ordinary High Street banks - which would be included within the ring-fence - were less prone to collapse than investment banks.

"The biggest banking disasters have been simple banks. The largest number of banking disasters have been simple banks," he said.

He pointed to the failure of Northern Rock, the 1980s crisis among US savings and loans banks and the more recent Spanish banking crisis as examples of banks that would be expected to fall within the ring-fence getting into serious trouble.

He and Peter Sands, chief executive of Standard Chartered Bank, both said it was wrong to believe that it was dangerous to mix the cultures of investment banking and High Street or retail banking within the same institution.

"The heart of the mistakes that banking made was not putting serving customers well first," said Mr Hester.

"[Banks] too often saw customers as being somebody from whom to make money," he added, indicating that this was a cultural problem for the bank as a whole and not just an issue of the investment bank.

'Commando-like'

Mr Sands agreed that he wanted to see a single culture across the bank and a "whole-bank approach".

Crisis jargon buster
Use the dropdown for easy-to-understand explanations of key financial terms:
AAA-rating
The best credit rating that can be given to a borrower's debts, indicating that the risk of borrowing defaulting is minuscule.

He also said the ring-fence would increase risk, because the bits of banks inside the ring-fence would be more restricted in what they could do and they would become like one another, meaning that their investments would be less diversified and they would all be likely to suffer from the same bad investments at the same time.

However, Lloyds chief executive Antonio Horta-Osorio, who was also giving evidence, took a different view.

"I strongly believe that the culture [at investment banks and High Street banks] is very different," he said, noting that he had run many banks in different countries - including Brazil and Portugal - and had always kept the two in separate subsidiaries.

He described investment banks as being a "commando-like organsation", because their activities were organised on a deal-by-deal, task-by-task basis.

In contrast, he compared retail banks to an army, due to their much more hierarchical structure, with bankers being given more clearly defined duties.

He was the only one of the three to come out in favour of the ring-fence, which he believed was necessary to separate the two banking cultures.

The Lloyds boss also believed that, by sealing off the activities of core importance to the UK economy, the ring-fence would make it easier for the government to deal with banks that went bust.

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