Banking and Politicians

By Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Politicians in Britain are constantly targeting banks for, in their words, massive unwarranted bonuses, getting us into the mess we’re in, failure to lend and generally anything else that has gone wrong.  Investment banking is often referred to as “casino banking” and derivatives are referred to in terms that suggest they are the root of all evil.

 

As usual, when politicians become involved, there is a massive amount of misleading information being bandied about.  It generally comes from one or more of ignorance, pandering to the crowd, living in some sort of dreamland and, their speciality, deflecting attention from their own shortcomings.

 

Most politicians probably don’t know what a derivative is, and certainly wouldn’t be able to distinguish between an FX future and a long-term synthetic structure.  Do any of them really think that if across the board bonuses had been half or even a quarter the level they actually were in recent years, other conditions being the same, that bank behaviour would have been any different?  And while ranting on about reckless lending in the past, they call for a return to the same levels of lending!  “We’ve got to get the banks lending again” is a familiar refrain.  It seems that if only that would happen we would return to a land of wine and roses.

 

Of course, along with consultants, banks are easy and perennially favourite targets for politicians.  Objectivity and accuracy seem irrelevant.  To be fair, the banking industry has brought many of the problems upon itself.

 

The level of some of the bonuses seems obscene to many, including me in some cases.  However, it misses the point.  What is the point?  I’ll get to that anther time, but would welcome comments on that topic in the meantime.

Which side of the ring-fence are you on?

by Stephen McPhie, CA

Partner RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

The UK government recently announced proposals to “ring-fence” bank’s retail from their investment banking operations.  The underlying idea is that the government would allow investment banks to fail in the event of a future financial crisis and that retail banks would be safer.  Presumably investors would believe that retail banks could be bailed out. 

 

Moody’s warned that this is a credit negative event making bank downgrades more likely.  And others have warned that it will raise costs for consumers and small businesses.

 

We actually need to see the mechanics of such a scheme.  Many operations are obviously retail or investment banking but there are grey areas, e.g. structured products and the cut off point between small and large corporate business, so where would they be put?  Importantly, how would the existing capital be allocated to each operation? 

 

A lot of smart people have been very skilled at peering round Chinese walls and reclassifying one type of asset to look like another.  Would the proposed ring-fencing be different this time?

 

And of course, the major UK bank failures had little to do with investment banking operations and lots to do with retail banking.  Furthermore, Lehman Brothers, which started a lot of dominos falling, had no retail banking operations.  So what benefit would ring fencing have brought if it had been in place for the last few years?

 

Is it a well-conceived way to protect peoples’ businesses and the economy?  Or is it a political response to an inability to institute effective corporate governance and regulatory oversight?

Making banks safer – UK style

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

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.