Monday, 12 September 2011

Why Vickers is right and what the critics don't understand

The critics started early for Vickers report on the future of banking today.  At least at 6.15 on @R4today experts weighed in on how ringfencing will not work.  In particular, a commentator said that Northern Rock was a retail bank but still got into difficulties.  So, they said, separation won't work.

I think this criticism misses a very important point which is on page 9 of report.  In essence it is this: some critics think the purpose of Vickers is to stop banks going bankrupt.  It is not.  In some cases, we might actually want banks to go bankrupt.  The essence is to have a structure so that we know what to do when banks get into trouble: rescue them, make them go bankrupt, allow them to merge etc.

Vickers says this:

"structural separation should make it easier and less costly to resolve banks that get into
trouble. By ‘resolution’ is meant an orderly process to determine which activities of a failing
bank are to be continued and how. Depending on the circumstances, different solutions may
be appropriate for different activities. For example, some activities might be wound down,
some sold to other market participants, and others formed into a ‘bridge bank’ under new
management, their shareholders and creditors having been wiped out in whole and/or part.
Orderliness involves averting contagion, avoiding taxpayer liability, and ensuring the
continuous provision of necessary retail banking services – as distinct from entire banks – for
which customers have no ready alternatives. Separation would allow better-targeted policies
towards banks in difficulty, and would minimise the need for support from the taxpayer. One
of the key benefits of separation is that it would make it easier for the authorities to require
creditors of failing retail banks, failing wholesale/investment banks, or both, if necessary, to
bear losses, instead of the taxpayer."
In other words, if a future Northern Rock Utility Bank gets into trouble, regulators know that it is a retail bank and part of the banking "utility"  rather than the "casino".  So we know what to do: we might want to bail it out, or let it go under in an orderly fashion etc.  If a future Northern Rock Casino Bank gets into trouble, likewise regulators know what to do.   (In any case, with higher capital requirements we should hopefully avoid this problem to start with).

What this means is that the scope of activities across the ringfence is very important, as Goodhart has pointed out (the boundary problem).  That is going to need some canny regulators, which does seem like a very big ask (declaration: I was on the Competition Commission for eight years).

Finally, outside the detail, to me there is an even bigger point.  We now know that successive governments have been near enough in the pockets of News International.  So far, they have been near enough in the pockets of the banks too.  Implementing these reforms is the first step to changing the latter.  If the reforms are stopped then we know our democracy has been truly subverted.

I look forward to hearing Sir John on Today at 8.10.

Update.  Sir John, in my view, very authoritative on Today just now.  Humpers asked him, rightly, "you cannot legislate against recklessness" and about Northern Rock.  John replies: get incentives right (i.e. have higher capital requirements) and be in a position to deal with if bank gets into trouble (which separation helps).