The ring-fence is an unhelpful distraction
by Jonathan Edwards
The "retail ring-fence" was at the centre of the Chancellor’s Mansion House speech and the Independent Commission on Banking’s (ICB) consultation on reform. But it is hard to see why the concept deserves this prominence.
As Stephen Hester of RBS has pointed out, the ring-fenced part of a bank will be viewed as being "too important to fail". This matters because, if the ring-fence is drawn widely, as much as 45 per cent of total UK bank assets could fall within the ring-fence, according to the ICB. If we want to reduce the problems caused by the “too important to fail” syndrome, the conclusion must be that the size of the ring-fence should be minimised.
Similarly, one of the ICB’s key arguments for the ring-fence is to instil confidence that a bank's retail activities can be separated easily in a crisis. However, if the ring-fence is drawn widely, so as to include not just basic functions but also other activities such as corporate banking, the resultant complexity will defeat the ICB's aim. Again, this suggests that the ring-fence should be drawn narrowly.
With these factors pointing towards minimising the size of the ring-fence and, as a result, its impact on the financial system, there is no reason to think that the ring-fence is the answer to the problems exposed by the crisis.
The Government would do better to refocus attention on the parts of the reform agenda which have a real chance of limiting the extent and probability of future crises. More thorough supervision will be vital, as will generating effective competition between banks. But the surest tool for reducing the impact of future crises is to implement much more stringent capital requirements across the board. The ring-fence is becoming a distraction from this critical task.
Ralph Musgrave
Re retail ring-fencing the above article says “But it is hard to see why the concept deserves this prominence…” The reason is thus.
Retail accounts will always, because of political pressures, be guaranteed by taxpayers. Thus to use money from such accounts for risky commercial ventures equals a taxpayer subsidy of commerce, which is a misallocation of resources. Or as Mervyn King put it, “If there is a need for genuinely safe deposits, the only way they can be provided, while ensuring costs and benefits are fully aligned, is to insist such deposits do not coexist with risky assets”.
As to the second paragraph above, this argues that the smaller the proportion of the banking industry’s activities are regarded as “too important to fail” the smaller the “too important to fail” problem. That is strange logic. It’s much the same as saying that the fewer activities that are classified as criminal, the smaller the crime problem. Ceasing to classify rape or fraud as crimes is not brilliant news for those raped or for victims of fraud.
Having defended ring fencing above, I don’t think that ring-fencing RETAIL activities is entirely logical. Reason is that there will always be retail depositors who want to have a flutter, and have their money invested in commercial ventures, and bully for them. Likewise there will always be large commercial entities who want specific sums of money to be 100% safe – and there is nothing wrong with that. Thus the fence needs to go between 100% safe and “commercial” accounts, not between retail and wholesale. The latter idea is advocated in a submission to the banking commission authored by Prof R A Werner, Positive Money and the New Economics Foundation.