Banks still too big to fail

Responding to the consultation paper on banking reform published by the Chancellor today, nef (the new economics foundation) finds the reforms do not go far or fast enough to deliver a stable financial system:

• Still too big to fail: banking system remains inherently unstable;
• Flexible ringfence allows banks too much room for manoeuvre;
• Reforming after 2015 is too long to wait: we may have to bail out banks again;
• More action is needed to reform the banking system.

 Lydia Prieg, finance researcher at nef said:

“Even an outright separation between retail and investment banking –which is not what we are getting– would leave individual banks with asset ratios equal to approximately 100% of the UK’s GDP i.e. that are too big to fail.

“Critics will say these reforms already come at too high a price, but even the government’s upper estimate £8Bn is a drop in the ocean compared to the cost of another banking bail out and still means we subsidise banks by approximately £40Bn a year [as a result of their too big to fail status]

“We are kidding ourselves if we believe that these reforms will mean that taxpayers won’t be called upon to bail out troubled banks again. The UK will still have banks that are too big for our economy and the banks will still have their own private welfare state. “

Tony Greenham, head of finance and business at nef said:

“We welcome the government’s decision not to water down the Vickers Commission any further, but the ICB’s recommendations do not go far or fast enough to reform the banking system.

“2015 is too long to wait for these reforms and leaves the public exposed in the (increasingly likely) event of another financial crash –we might have to bail banks out again. It also gives banks years to lobby for laws to be watered down even further.”

“As Vince Cable himself acknowledged in July, a ring fence Vickers will not be as effective as a full separation of retail and investment banking. A flexible ring fence gives banks too much room for manoeuvre and could prove a regulatory nightmare to enforce.”

Still too big to fail

• None of the government’s proposals will alter the fact there are individual banks with asset ratios equal to approximately 100% of the UK’s GDP. Large, interconnected banks remain too big to fail, leaving the UK taxpayer exposed in the event of their collapse.
• Separating retail banking away from investment banking will not eliminate this problem. It will only reduce the extent to which banks can borrow cheaply as a result of their implicit government guarantee (the so-called "too-big-to-fail" subsidy, which nef estimated to be £46Bn in 2010).
• In the last 25 years we have allowed banks to balloon in size. Until the 1970s, banks' assets as a percentage of UK GDP remained steady at approximately 50%. By 2006 after decades of deregulation, banks' assets as a percentage of UK GDP were over 500%.

Flexible Ringfence: a regulatory nightmare

• The flexible ringfence lets banks decide whether numerous activities (e.g. lending to consumers, businesses and trade finance) count as retail or investment activities.
• This gives banks too much license to write their own rules and will prove overly complex for regulators.
• In addition, ring-fencing incentivises banks to take greater risks with activities inside the fence, because they are more confident of being bailed out.

Waiting until after 2015 risks another banking bail out.

• 3 years on from the banking bail out and British taxpayers are being asked to wait another 8 years for reforms to be enacted.
• The longer we wait for reforms the longer the taxpayer is exposed to a second banking bail out –increasingly likely in the current economic climate.
• Delaying reforms gives banks time to lobby against proposals and water them down even further.

More action needed

• Even if all the Vickers’ commission proposals were implemented tomorrow, Britain would still not have a banking system that was safe and fit for purpose.
• The big banks no longer meet the needs of the UK’s savers, borrowers or investors and the diverse enterprises that make up UK PLC.
• The Independent Commission on Banking was meant to address the lack of competition in UK banking, but its final report came up with no significant proposals.
• The emergence of Metro, Virgin Money and the sale of Lloyds branches is a step in the right direction but only part of the picture, the UK remains one of the most concentrated retail banking sectors in the West.
• Vickers’ proposals seek to curb some of the worst excesses of bad banking, but they fail to ask the more important question, ‘what does good banking look like?’