Ring Fencing the banks

Today the Vickers Committee on Banking published its report and, as predicted, came out in favour of ring fencing.

The idea here is that investment banking and commercial banking are two quite different types of risk and one type should not subsidise the other. The first instance of this was in America in the 1930s and called the Glass-Steagall Act (GSA). The GSA however simply forbade banks from operating the two different functions: they had to be one or the other. As I outlined in a much earlier post, total separation is not however necessary. Ring-fencing would mean Barclays Group could own Barclays Bank and Barclays Investment Bank but that one bit couldn’t subsidise the other.

I am broadly in favour of Ring Fencing but with a few caveats. The first thing is that it isn’t the be all and end all of solving banking risk. It really isn’t too difficult to go bust as a commercial bank, either by making too many bad loans, as several banks nearly did in the 1970s and 80s, or by getting the funding wrong, as Northern Rock did. ‘The Rock’, as it was mistakenly called, didn’t have an investment banking arm and no amount of ring fencing would have saved it.

And then, of course, when a commercial bank was in trouble, it might be useful to rely on the funds of a successful and profitable investment bank: I have repeatedly said ‘one shouldn’t subsidise the other’ and whilst the Vickers Report seems to think the risk is that investment banks will get into trouble and take away the capital of commercial banks, it can go both ways.

The other caveat is the cost. Some figures suggest that it might cost the City $7 billion to implement the proposals and whilst others come in lower there will definitely be a substantial cost to this, just at a time when we need the banks to be doing more lending to private sector companies so they will expand and take on workers formerly in the unproductive public sector. Competing financial markets in America, the Far East and Europe aren’t proposing ring fencing.

My view is that we should do this, but not until there are clear signs that we are through the worst. And that isn’t now.