Vickers report is harsh but necessary
Bankers have been vocal in their opposition to the recommendations from the Independent Commission on Banking's final report, with some threatening to leave the country if regulation becomes too severe. But in economies where the financial sector has the potential to bankrupt the entire country, regulators are right to protect the economy.
If the UK government goes ahead with the recommendations in the Independent Commission on Banking’s final report, it will give the country the toughest financial regulation in a developed market.
Published last month, the so-called Vickers report (after the commission’s chairman Sir John Vickers) provides what might be termed a Swiss finish plus a British finish.
The Swiss finish comes in the form of loss-absorbing capital for retail operations of 17% to 20% including 10% equity (Switzerland demands 10% core Tier 1 and 19% total), while the British finish separates retail from investment banking in a hark back to the strict divisions of the US Glass Steagall Act of 1932 that came out of the 1929 crash.
The Vickers ring-fencing is not so severe and tries to be flexible enough to allow banks to retain important elements of universal banking. Banking services to large domestic non-financial corporates, for example, can be conducted in either part of the bank. Agency arrangements in groups would allow ‘one-stop shops’ for clients wanting both retail and investment banking services.
Nevertheless, it will still require leading UK universal banks such as Royal Bank of Scotland and Barclays to reorganise and to hold considerably more capital in their retail operations than previously. Helpfully they are likely to have until 2019 to comply.
UK bankers have been huffing and puffing about Vickers for some time and there have been veiled threats to leave if the rules proved too harsh. But from a dispassionate point of view it is hard to argue against the logic of the report and it could well be that other jurisdictions borrow elements of it.
The overwhelming case for tougher rules in Switzerland and the UK is that they both have financial sectors that dwarf their economies. Banking assets are roughly four times gross domestic product in both cases. This means that a severe crisis has the potential to bankrupt the entire country. The news in September that rogue trader Kweku Adoboli had lost $2bn for Swiss investment bank UBS in its London operations again highlighted the dangers.
Vickers sets out to address this by ensuring that retail is kept separate from and better capitalised than investment banking so that, in theory, investment banking activities can be allowed to fail without disrupting the retail operation. Investment banking is required only to comply with the international standards of Basel III.
The other key piece of logic is that finance is now more globalised than ever, so increasing the potential for trouble from an overseas operation to loop back and disrupt domestic operations – as happened in 2008 when problems in the US subprime market spread around the globe.
Of course retail banks are still capable of getting themselves in trouble, as illustrated by the failure of Northern Rock. Perversely, the UK cannot stop ring-fenced banks lending in other eurozone countries as that would be in breach of EU rules. But in producing a sensible, measured, regulatory response to the crisis and the particular challenges of the UK, Vickers has taken best practice a long way forward.
