The Vickers Report in the UK has made three main recommendations which the government will implement, it claims, pretty nearly in full. Firstly apologies to our many North American readers but the same may happen to you in due course so it is instructive to consider the consequences. Bear with me please because there will be knock-on effects in the global market. It may well be that some of these reforms also find their way into the Eurozone, possibly not a moment too late. Despite the recent spats between leaders, wiser heads on both sides of the Channel do recognise the importance of London as a financial centre and it seems that Britain will have an observer role in the reconstruction of the Eurozone systems.
The biggest immediate effect over the pond will I suspect be the downsizing and probably removal of the Royal Bank of Scotland’s investment presence in the US as that bank, largely in public ownership, will be refocused on the UK according to the statement in the House of Commons this afternoon by the Chancellor of the Exchequer.
The main Vickers recommendations are
- to split their European retail banking assets, liabilities and services into separate subsidiaries in order to ‘ring-fence’ retail from investment banking,
- to promote retail deposits (savings) ahead of unsecured loans in case a bank goes bust which means that unsecured lenders will be more careful where they place their money in future and
- insist that the retail components of banks should be capitalised not at 7% as Basel 3 recommends nor at 10% as the UK Treasury had been suggesting but for the larger UK banks with an international presence, at 17-20% of their UK balance sheet.
The original Vickers’ recommendation for the larger banks was for 17-20% on all assets but this has been watered down to be only those which will affect the UK taxpayer. You can see the sense in that – if one of the giant UK banks goes under despite all this, you don’t want the UK taxpayer bailing out the deposits held overseas in other currencies and HSBC in particular argued this point on the basis that the majority of its business was overseas and it would mean raising an awful lot of (dead) money.
This will all be enacted in Parliament by 2015 and has to be completed by 2019.
It all sounds great but what does it mean and will it work?
Let’s start with the good news. Deposits will be protected ahead of unsecured creditors. This will reassure the former and keep the latter on their toes. The former are of course the ordinary people and businesses, the latter are those shady folk who float billions around the world all day.
Now the bad news.
First it means substantial money will have to be raised by the banks. They have already moved from the rather paltry few percent of capitalisation to approaching the 10% required. Along with trying to recover their losses (most banks were not of course nationalised), repaying loans from the government needed to avoid complete collapse in 2008, this has meant a substantial reduction in lending, only eased by the Bank of England printing money – ie doing what the private banks had been doing rather too willingly up to the crash. So this lending freeze will carry on at least for UK loans until the 17-20% is reached. Which means surely that the BoE will have to carry on pumping money in and/or the impending recession will be longer and worse.
Once all this has settled down, the penny will drop that lending in the UK will not be as profitable as lending elsewhere. Remember my calculations of why banks love to lend? The increase in capitalisation means that the effective yield to the bank (interest rate as they see it) is just about halved so your 4% 20 year mortgage is worth not 72% yield on the 10% required but a paltry 36% to them, an 8% car loan over 4 years will net only 145% yield. Boo hoo. Champagne halved this year, chaps. And next year…
Expect therefore banks with overseas operations to favour areas where they can still make a shed load which is better than half a shed load. Or banks will offer off-shore lending at a slightly lower interest rate where they can still clean up on profit. Nice one – all outside the regulatory control I expect.
Secondly I am rather puzzled about this ring-fencing. Where will the banks place their 20%? According to the recommendations, 10% should be in top-quality form such as shares and retained earnings, the rest in bonds that can easily be converted into equity. Now wait a minute – shares? What if the stock market goes south? Bonds? Which? And if they have to sell either in vast quantities (as would be the case), who will buy them at what price? If a bank goes down, the price of any backing asset will drop like a stone so what protection is that? The ‘quality’ of any backing instruments will be verified by whom? The same ratings agencies that have let us down in the past? Lastly, the banks clearly had problems before in finding sufficient good places to put their few percent before, so how in these days are they going to find secure repositories for substantially more, particularly as all other banks in the world will at least have to follow Basel 3? Nothing seems to be said about this.
Expect international banks to set up off-shore operations providing ‘products’, pay the ratings agencies their loot to AAA-rate them, dump their 20%s in these ‘vehicles’ and carry on playing as they have been doing with impunity so far. Why? Because they can, because it’s more profitable and no ordinary audit trail will be able to follow the money. Not a lot will have changed. I would have thought that the best place – in fact the only place – for such money is with the central bank and for Sterling, the 20%s should be deposited with the Bank of England. End of.
And what about non-UK banks operating in the UK? Does this mean the same for them too? There are a lot of them. Will they need to obey the same regulations? What if the EU passes different standards? Which will they obey? And if the UK standards are stiffer, will they complain to the EU and take their ball away? It seems to be party time for the lawyers.
Of course some people are saying – why wait until 2019? Apart from the legislative delay (and expect some rearguard action from the banks’ friends), it does mean that this reduction in lending will be over 4 years (or if they realise the game is up and start immediately, over 8 years) which is more manageable. During which time of course the banks are still vulnerable, particularly to events in Eurozone.
Lastly, as was shown in these columns recently, these banks are among the biggest financial organisations in the world and are all intimately connected with cross-board ownership. It is very difficult to control such institutions because they control us.
I don’t object in principle to the Vickers’ report but do find it rather difficult to see that it will do much good at all particularly in a global economy where assets can be moved so quickly. The Three Taxes proposals made recently would be a better – or additional – way of regulation, much lighter and more difficult to evade, reduce central bank liability, reduce market volatility and benefit businesses and consumers much more visibly.