by Stephen McPhie, CA
Partner, RSD Solutions Inc.
In Britain, an independent Commission on Banking, set up to determine how to make the banks safer, has recommended that retail banking be ring-fenced within a bank from its investment banking operations by having the latter in a subsidiary. Some people had called for a break up of the two sides of such banks – a sort of latter day Glass-Steagal. The thinking being that investment banking subsidiaries would be allowed to fail while retail banking would be well capitalized and benefit from implicit (or explicit) government support. However, the commission did not go this far. There had been a certain amount of scaremongering by banks and others that some banks might move their head offices out of Britain and with them thousands of jobs.
Quite apart from unaddressed issues such as where to draw the line between the two businesses as there are many possible grey areas, or when can capital flow down to the investment bank or be required to flow up to the retail bank, is this a useful approach in principal? What was seen as the trigger for the global financial crisis was the demise of Bear Sterns and this was a pure investment bank. If a similar circumstance arose again, would such an operation be allowed to fail? (Actually the true cause of the crisis was bad lending decisions facilitated by an environment of great liquidity enhanced by factors such as opaque derivative structures, weak regulatory oversight, etc.) The problems of British banks were caused largely by straightforward bad lending decisions, without much help from investment banking operations and opaque derivatives. How would such ring fencing helped?
How did markets react to the ring-fencing recommendation? Shares in the two biggest banks with major investment banking operation rose significantly on the news. Wisely, banks said they do not like the recommendation. Wisely, because there is a negative mood against banks by public and politicians. With that background, it would not be politically astute to gloat when you may suffer a slight inconvenience but have most of what you want.
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