Posted on by John Sloman

Taking the gambling out of high street banking (update)

Original post (19/9/11)
The Independent Commission on Banking (ICB), led by Sir John Vickers, has just delivered its report. Central to its remit was to investigate ways of making retail banking safer and avoid another bailout by the government, as was necessary in 2007/8.

The report recommended the ‘ringfencing’ of retail banking from the more risky investment banking, often dubbed ‘casino banking’. In other words, if the investment arm of a universal bank made a loss, or even faced collapse, this would not affect the retail arm. The ringfenced operations would include banking services to households and small businesses. Wholesale and investment banking would be outside the ringfence. As far as retail banking services to big business are concerned, these could be inside the ringfence, but details would need to be worked out about precisely which banking services to big business would be inside and which would be outside the ringfence.

The ICB was keen to stress that the ringfence should be high and that the retail arm should be both operationally and legally separate from the wholesale/investment arm. The ringfenced part of the bank should have a capital adequacy ratio of up to 20% (above the Basel III recommendations), with at least 10% of liabilities in the form of equity. Capital could only be moved from the ringfenced arm to the investment arm of the bank if this did not breach the 10% ratio.

The ICB report also recommends measures to increase competition in banking, including making it easier to switch accounts, greater transparency about the terms of accounts and a referral of the banking industry for a competition investigation in 2015. The cost to the banking industry of the measures, if fully implemented, is estimated to be between £4m and £7m.

Because of the requirement in the report for banks to build up their capital and the danger that a too rapid process here would jeopardise the expansion of lending necessary to underpin the recovery, banks would be given until 2019 to complete the recommendations. Moves towards this, however, would need to start soon.

Update (19/12/11)
In December 2011, the government announced that it would accept most of the ICB report, including separating retail and investment banking. It would not, however, demand such stringent capital requirements as those recommended in the report.

The following articles examine the details of the proposals and their likely effectiveness. The later articles examine the government’s response.

Original articles (some with videos)

Audio podcasts

ICB report and press conference

Later articles and webcasts

Questions

  1. Explain the difference between a capital adequacy ratio and a liquidity ratio. Will the Vickers proposals help to increase the liquidity of the retail banking arm of universal banks?
  2. Does it matter if equity capital in excess of the 10% requirement for retail banking is transferred to a bank’s investment arm?
  3. What risks are there for a bank in retail banking?
  4. What are the advantages and disadvantages of bringing in the measures gradually over an 8-year period?
  5. Does it matter that the capital adequacy requirements are higher than under the internationally accepted standards in Basel III?
  6. Assume that there is another global financial crisis. Will the proposals in the report mean that the UK taxpayer will not have to provide a bailout?