George Osborne to back 'ring-fencing' of retail banks

According to The Telegraph, Friday 17th June 2011, the Chancellor will give his public support to proposals from the Independent Commission on Banking (ICB) for UK-based banks to adopt a so-called “subsidiarised” model that will mean in the event of a future crisis the authorities will be able to seize the retail arm of a troubled institution.

There are voices, however, who claim that the proposed reform will not be sufficient:

Lord Lawson, the former chancellor, has called for the retail and investment arms of Britain’s banks to be fully separated, warning that the proposed ‘ring-fence’ may not be watertight, according to The Telegraph, Friday 17th June 2011

Although he welcomes the proposals, he warned bankers would want any firewall to be permeable and said it could be “difficult” for different corporate cultures to co-exist within a bank.

“The problem with this is while it is intellectually a sound move, the problem is that in practice, with the pressures of the real world, the ring-fence will not actually – to mix metaphors – be completely watertight. It might break down.

“It’s very difficult when you’ve got the same management, the same board, the same group of shareholders,” Lord Lawson said.

He said he welcomed the proposed ring-fence, but added: “I hope, incidentally, that the government will go further.

“The point is not only to secure the economy for the future, but to protect the taxpayer. It is absolutely intolerable that investment banking is bailed out if it fails.

“At the end of the day there is a tax-payer guarantee for retail banking. That should not extend to investment banking. If investment bankers make a mistake they should go bust.”

Lord Lawson is not the only one who is afraid that the proposed reforms might fall short.

Richard Meddings, senior banker of Standard Chartered has warned that the Chancellor’s array of banking reforms will not do their job unless the new Financial Policy Committee is prepared to intervene directly to stop markets overheating, according to The Independent, Friday 17th June 2011

He said: “We would question whether regulators have sufficiently worked out the aggregate consequences of the breadth and depth of regulatory change in such a short period of time on banks’ capacity to provide credit to the economy.”

He also said the FPC should increase the liquidity reserves banks have to hold with the Bank of England when credit is too lax because that would reduce money for lending and make the central bank more liquid.

Such actions are also strong signals to the banks and consumers that things are getting out of hand, he said.

“The central bank says, ‘We are taking away the punch bowl.’ The only thing we have here is raising interest rates and we can’t do that now because so many people are worried about interest rates because they have over-borrowed.”

While it may seem that “ring-fencing” is the step in the right direction, it is also possible that the results of such a “not enough radical reform” could turn out to be not sufficient or even opposite from the original intention. If there is a fundamental deep error in the system, the trials to fix the superficial symptoms will not work in the long run. Obviously it’s easier for the politicians to keep re-arranging the deckchairs on the Titanic of the problem, rather than get to the nub of it.

The nub of this problem is that private banks are legally allowed to expand the money supply through the issuance of debt.

The Independent Commission on Banking still doesn’t appear to understand how modern banks actually operate.

Unless the ICB, Mr Osborne, the Bank of England and the Treasury start to take more seriously the true role of banks as the creators of the overwhelming majority of money in the economy, there is little hope for effective reform.