Saturday, 29 January 2011

An eventful week for banking...

Did you notice what an eventful week it has been for banking and finance?!

It began with Sir John Vickers' speech last Saturday at the London Business School, which outlined the current thinking of the Independent Commission on Banking (ICB). It was a level-headed review of the problems and possible solutions, which posed many questions. Sir John went further than most of the bodies currently addressing the problems in finance by being open to the idea of separating the activities of banks, in aim to protect the ordinary retail banker from risky investments. In response, some banks (big effort by Barclays) argued that there was no evidence that splitting up the banks would reduce risk. RBS estimated that such measures would cut their profits by up to £4.8bn a year. On the other hand, George Mathewson (ex- RBS CEO) told the ICB that they really should consider breaking up RBS and Lloyds to promote competition. Meanwhile, on Monday Project Merlin - negotiations designed to cut bankers bonuses - failed (thank goodness). Oh, and I interviewed Sir John!

I'm not allowed to share our conversation yet ... but let's consider what he said in his speech in London. You can read it in full here. (I can tell you that Vickers has the most adorable dog named Alfie and, as warden of All Soul's College, resides in a classic English home that reminded me of Jane's and Michael's in Mary Poppins.)  

There are three main tools that the ICB consider useful in increasing stability in the banking system: 1) Increasing capital requirements, 2) Creating resolution mechanisms, and 3) Separating or 'ring fencing' certain bank activities. There are many open questions as to how each would work, but I shan't go into that. 

The most significant insight for me has been that the ICB does not believe that, in our world and within the remit of UK-only regulation and reform, crises can or should be eliminated. This is because they believe that there is a trade-off between reducing risk and encouraging economic activity. For example, if you increased capital requirements a bank would not be able to lend as much, and so there would be fewer borrowers spending money in the economy. They also think that risk is an inherent part of the financial system: channelling savings into investment opportunities will always carry some risk (entrepreneurial projects, mortgages and pensions all involve some risk).  As a result the ICB only expects to reduce the impact and frequency of financial crises. I want to look into this trade off more... How do you measure the benefits and costs of reduced borrowing? Apparently Professor David Miles (one of the roundtable participants!) is doing work on this at the moment. I know there are many 'radicals' who believe both that the reduced economic activity is a price well worth paying to create financial stability because a lot of economic activity is in fact be harmful.

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Let me tell you about my impression of Project Merlin. It was an initiative set up by the coalition which aimed to 1) shrink banker's bonuses, 2) let the public know who were the highest paid bankers, and 3) increase lending from banks to businesses.  I say 'thank goodness' that negotiations broke down on Monday because in return for these short term sacrifices from the banking sector, the coalition was willing to reduce the future threat of taxes and regulation - long term actions that could actually make the financial system more resilient.

Specifically, the banks were asking for a "level playing field" with other big financial centres across the globe. After Sir John's speech on Saturday, however, it seems hopeful that the ICB will be considering much more than how well the banks can compete globally, which will affect their profits and bonuses.

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