Vickers Commission Response: Ring-fencing doesn't solve the "too-big-to-fail" problem

Tony Greenham, head of Finance and Business at nef (the new economics foundation) said:
“The ICB’s report is a welcome official recognition that the system is bust. But the arguments against a full split are unconvincing. We know that full separation works – it worked for most of the last century in the US. This bureaucratic compromise is uncharted territory, and with ample time for the lobbyists to get to work there can be little confidence that it will be effective enough.”

“The suggestion that some of the largest and most powerful companies in the country, run by the most highly paid executives, need 8 years to implement reforms is a slap in the face to public servants who are being asked to radically restructure vital services within a matter of months.”

“This report does not deliver a safe and useful banking system. We have had no proper investigation into the causes of the crash, or into the conduct of the banks leading up to it. There is insufficient consideration of the broader public benefit, and nothing to curb the socially useless excesses of investment banking.”

Neal Lawson, Chair of Compass, said:
“Three years on from a crash that they created and the banks are given 8 years to find their way through a ring fencing system that is bound to leak information and capital flows. Instead of recommending the simple and effective step of complete bank separation the British establishment has bottled it and the City has won again. Nothing changes; the state will have to under-write the banks, people’s savings will remain in jeopardy, businesses will be starved of investment funds and the bankers will still be rewarded with £millions in bonuses for taking reckless risks.”    

The groups argue that the ring fencing model has many disadvantages compared to complete separation: 

• Ring fencing doesn’t resolve the issue of some banks being effectively too large and too interconnected to be allowed to fail. We will still have banks with assets in excess of UK GDP. In addition, capital levels have historically poorly reflected the riskiness of an institution, and so we should not place undue faith in stricter capital requirements. This means that the risks of financial system will still be underwritten by taxpayers, with the benefits accruing to a small number of financiers.
• There is a question of whether the public understand the subtleties of ring-fencing during a financial crisis or will the ‘universal branding’ of the ring fenced banks lead to a run on a bank’s retail arm anyway if customers perceive the investment arm to be unsound. 
• The ring fencing model provides less protection against financial contagion. The ICB acknowledged in its interim report that “full separation might provide the strongest firewall to protect retail banking services from contagion effects of external shocks”.

Compass and nef also have other concerns about the report:

• We need retail banking to return to a simpler world, where shareholders expect more moderate rates of return. The extremely high returns on equity seen over the past decade are unrealistic and unsustainable. This shift in expectations would help mitigate the extent to which banks will pass on the costs of higher capital requirements to their customers.  
• The ICB report once again completely glosses over the role of banks in creating the money supply. The assumption throughout is that bank’s primary role is as intermediaries, lending out deposits in the form of loans.  In reality, it’s the other way round - deposits are created when banks make loans.  The ICB’s rejection of more radical proposals, such as narrow banking and nef’s full-reserve banking, appears to be borne out of this misunderstanding.  Indeed, bank’s key economic role is as the creators of credit in our economy is not mentioned once in the entire 358 pages.
• We have still had no vision about what kind of banking system will best serve the broader public interests, beyond the failed mantra of competition cures all.
• Four years after the start of a global financial crisis that still engulfs us, to which the UK was more exposed than any economy in relative terms, we have had no enquiry into the causes of the crash or the conduct of the banks leading up to it.