Here’s how to read the report for non-specialists. The report is here: http://bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf.
- First look at Para 4.6ff, in particular Box 4.1 that shows the basic model of banking and how a shock is so devastating to highly levered companies. (The shock question is related to just what banks do: see Para 4.21 below in a moment).
- Paras 4.10ff then tell you why highly levered banks are bailed out by taxpayers. Para 4.10 talks about the key argument that economists call “externalities”. That motivates a subsidy, but creates moral hazard. The rest of the paras up to 4.20 talk about this.
- Para 4.21 makes an important point. The fundamental point of banks is maturity transformation. That is, borrowing short and lending long. That makes them uniquely vulnerable to confidence problems, which is why a guarantee is a very good idea: a solvent bank can go bankrupt, unlike a solvent company.
- Para 4.23ff are then more practical discussion, and are rather more technical. So I would then skip back to
- ..chapter 2, which is an overview of financial stability.
a. Note the vital feature of 2.7, namely that separation is not just about preventing bankruptcy, which cannot be done, but about making it more orderly (with high capital requirements to try to stave off the position to start with).
b. Note as well the very useful box 2.1 on page 3.1 about how Northern Rock etc. would have been different with these recommendations.
6. Finally, I would now read the executive summary, pages 7 to 18, to bring it all together.
Some final notes on FAQs on the crisis that the report addresses:
a. The key is too big to fail problems. Answer yes, page 14.
b. Northern rock was a retail only bank and failed, so this will not help. Box 2.1
c. RBS took over ABN and that was the problem. Answer, RBS borrowed to take over and would not be allowed to do so with more capital, Box 2.1
d. UK banks will be at a competitive disadvantage with respect to EU banks with less tight regulation. Answer, possibly. Para 2.21 , 2.23, 4.35.
e. The crisis was in the shadow banking sector, which this does not address. Answer, dealt with by other regulation, Para A2.19ff.
f. Only full separation will solve the problem. Answer, maybe, but there are some advantages to partial separation, Para 3.59ff. . Banks cannot provide data on economies of non-separation, Para 3.67. Separate governance is important.
g. The boundaries of a ring fence are too porous. Answer, this will have to be regulated as in the US, see Box 3.5, page 70.
h. The costs don’t outweigh the benefits. No, the costs of financial crises are very high, Para 5.8.
i. Having more bank competition is bad for financial stability. No, box 6.1, page 159.