Bank review focuses on financial stability

For months now the government-appointed Commission on Banking has been quizzing the UK’s big banks, taking evidence about flaws in the structure of the market and staging a series of Question Time-style debates nationwide to garner public sentiment.

The mission, simplistically, is twofold: to make banking in Britain both safer and more competitive.

But as the process proceeded, a consensus view emerged that Sir John Vickers, the commission’s chairman, was focusing on high street competition – largely because it can be tackled unilaterally in the UK, regardless of the international context. The view is that he might well dodge the other, more complex agenda, realising globally active universal banks that combine high street and riskier investment banking in one group cannot be unpicked unless the rest of the world follows.

Not a bit of it. While the commission could well still recommend action to curb high street market shares – particularly relevant for Lloyds, which controls up to 30 per cent of some products, such as current accounts – financial stability seems very much to be back at the core of Sir John’s agenda.

As the evidence-gathering process has drawn to a close in recent weeks, commissioners have been asking banks and other interviewees about the likely impact of ring-fencing a bank’s subsidiaries.

By September, all will be made clear, when the commission publishes its final report to the government. But Sir John will give a sneak preview of his thinking in a speech at the London Business School on Saturday, prefiguring the direction of an interim “options paper” in April.

According to people familiar with the commission’s thinking, Sir John will use his speech to stress the various permutations of subsidiarisation.

The most extreme form would allow a group merely to share a brand. That would bar the sharing of funding structures, forcing an investment bank unit, for example, to fund itself independently of the group, rather than rely on high street bank deposits and cheap bond finance issued by its parent.

“To do that you would have to improve your capital position, get an independent credit rating, build a history as an independent issuer,” says James Chappell of Olivetree Securities, an independent London stockbroker. Analysts estimate this would inflate funding costs, and therefore the charges passed on to clients, by tens of billions of pounds across the sector.

A less radical scenario could allow interbank lending between ring-fenced subsidiaries but still create a firebreak between them which would protect the group as a whole in the event of a crisis.

Banks with an investment unit that outstrips its retail operations, such as Barclays, would be hardest hit. As Bob Diamond, Barclays’ chief executive, told MPs last week: “If you look at Barings, it applied such a model, and when the problems occurred with its Singapore subsidiary, that did not prevent its failure.”

Critics say even banks operating with a largely subsidiarised structure, such as HSBC, did not benefit in the financial crisis because cutting off a troubled subsidiary is politically and reputationally difficult.

“What you really need is an effective resolution regime,” says a senior consultant. “Only that allows you to untangle a bank when it has failed, without comeback for taxpayers.”

Source: http://www.ft.com