The Osborne Ultimatum: banks must split or else

By Ian Fraser

Published: QFINANCE

Date: June 17th, 2011

The announcement from Chancellor of the Exchequer, George Osborne (pictured above), that British banks are going to be forced to “ring fence” their retail and commercial banking (“utility”) activities from their investment banking (“casino”) activities has received wildy different receptions on either side of the Atlantic.

In the US, financial bloggers were ecstatic in their coverage. Osborne was portrayed a conquering hero who had taken on the might of big finance and won. In a blog post titled The UK Is Preparing To Return To “Glass-Steagall”, Zerohedge blogger Tyler Durden said:-

[This is] an act which is in essence a reintroduction of Glass-Steagall. What is stunning about this development is that the banking cartel has allowed the UK to get so far as to effectively repeal Gramm-Leach-Bliley, the act that ended Glass-Steagall and allowed unprecedented deregulation to convert formerly safe banks into the mastodon, 50 times levered, TBTF hedge funds they are now. And if this is happening in the UK, how long before Europe adopts the same overhaul in order to placate its austerity-ired population, and deflect populist anger where it belongs: the banking oligarchy which continues to defy nature, and the simple laws of bankruptcy, and demands that there is never even the smallest impairment of senior claims. All this may very soon be changing…

And here is what Felix Salmon, finance blogger at Reuters, had to say about Osborne’s initiative:-

If you’re not going to break the big banks up, then the next best thing is to force their riskier arms to operate outside the protective walls of their too-big-to-fail retail operations. And the retail operations should be as bankruptcy-remote as possible, with extremely stringent capital requirements on the order of 10% of total assets …. Britain’s politicians are thinking constructively about how to rein in the more dangerous tendencies of its biggest banks ….

The reception accorded to the proposals on this side of the pond was startlingly different. Initially there were some niggling complaints that Osborne had announced his intention to enact a proposal, before the body that initially suggested it, the Independent Commission on Banking, has completed its final report. There were even some crusty City types who were appalled that Osborne had leaked an announcement that was meant to be unveiled at a Mansion House dinner on June 15.

Many UK-based commentators said ringfencing banks’ retail arms would actually increase moral hazard and make bailouts more, not less, likely. Jeremy Warner, of the Daily Telegraph, said that the proposals, even when accompanied by a higher-than-Basel-III rise in capital ratios to 10% plus (another ICB proposal) would “hardly get rid of the too-big-to-fail problem” nor obviate the need for future bailouts. He reminded readers that the UK banks that failed in 2007-08 were, for the most part, destroyed by the sheer recklessness of their retail and commercial arms, not by their “casino” activities. Warner said:-

“If everything within the ringfence is deemed utterly safe and guaranteed by taxpayers, it won’t be long before bankers find ways of exploiting this public subsidy with ever more high-risk forms of conventional lending. The casino will merely switch from the barrow boys of the City to the Captain Mainwarings of the local branch network.”

In a trenchant blog titled “Papering over the rot” former NatWest and RBS insider Frances Coppolla said Osborne’s proposals were very bad news indeed for depositors and taxpayers. She said:-

“If this was really going to hurt the banks, they would have fought this harder, wouldn’t they? Call me suspicious, but it’s hard not to conclude that it not only doesn’t hurt them, it directly benefits investment banking at the expense of retail. In effect, the retail ringfence protects investment banking from the consequences of excessively risky retail lending, leaving retail depositors bearing all the risk of this lending….”The rot at the heart of our banking system is the system of guarantees provided to retail depositors that spills over into lending activities and encourages excessive risk-taking. The proposed ringfence does nothing about that rot … And when retail banks start to collapse again while the investment banking sector flourishes, will we blame the investment banks again – or will we finally deal with the real cause of the problem?”

Simon Nixon, a fan of the regulatory status quo for banking and the City, writing in Wall Street Journal Europe, said Osborne’s proposals were “a leap in the dark that could have unintended global consequences”, warning that they might jeordardize London’s position as a leading financial center.

Other British commentators lambasted Osborne for being too timid and not going far enough. There are many — including myself — who suspect that the ringfences he is proposing to erect through “subsidiarization” will be porous,  and as ineffective as the “Chinese walls” that investment bankers claim to have erected inside their institutions. Often, as I said in an earlier blog, such walls are more mythical than real. Some commentators argue in favour of a full, forced separation of investment banking and retail banking activities.

I’m beginning to think the US commentators — whose response is of course driven by their exasperation with their own government’s foot-dragging on financial regulatory reform — may have a point. Osborne has stood up to the bankers and I suspect that if “ring fencing” does become law, it will start a process of separation that will lead to a version of Glass-Steagall by default. Whether this would make banking safer and less heavily subsidized, I don’t know. But I do know that in the 66 years between the enactment of Glass-Steagall in 1933 and its repeal by President Bill Clinton in 1999, US banking was one hell of a lot saner and less corrupt than it was in 2000-08 (if the Savings & Loan crisis is discounted, of course).

This article was first published on QFINANCE on June 17th, 2011


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