“Why should we bolt the stable door?” – The seperation of retail and investment banking.
George Osborne’s intention to legally separate (“ring-fence”) the retail and investment arms of banks is a positive thing, even if it somewhat resembles bolting the stable door after the horse has bolted. Stephen Hester, Chief Exec of RBS, unsurprisingly disagrees. I say unsurprisingly because, clearly learning the lessons of a banking crisis driven by pay packages which rewarded reckless short-term profit seeking in investments, the semi-nationalised RBS constructed a pay deal for Hester in which 85% of his staggering income is variable on immediate performance. Controls on the way banks operate are in a very real sense controls on how quickly Stephen Hester’s income can grow.
Incidentally, I’m puzzled as to where Hester is going with this, on the grounds that the Vickers’ Commission recommended ring-fencing on the premise that the alternative is “across the board” minimum capital reserves significantly higher than 10%. I can’t speak on Stephen Hester’s behalf, but I get the feeling he and his peers wouldn’t be thrilled about that either. I can only thus assume his preference is no change at all to the structure of banking; political suicide if nothing else.
Nonetheless, Hester has some interesting points. Firstly, he claims that a ring-fence actually increases, rather than decreases, systemic risk. Secondly, he points to the increased costs of retail banking if it cannot be subsidised by investment banking.
I’m more interested in the first, so I’ll quickly address the second issue before moving on. Undoubtedly, Hester is correct. Assuming that banks would find alternative ways to cover the costs of retail banking is naiveté. Ralph Silva, talking to the BBC, estimated an increase in the cost for customers of 10-15%. In the simple terms of cost-benefit analysis for the customer, this increased cost has to be offset against the cost to the taxpayer of bailing out huge simultaneous banking beasts. I’d flatly reject the idea that this cost is regressive given that evidently those on the lowest incomes suffer the most when huge swathes of public capital essentially have to be diverted into the financial sector. Beyond this rationalisation of the issue, this is an additional 10-15% for security; for knowing that your deposits are safe and that the national banking system is more secure – something I believe many people, including myself, are concerned by. Security and peace of mind, at the risk of sounding like I’m selling life insurance, are priceless. (Or, in less vomit-inducing terms, are certainly worth a small charge on your current account.)
On the issue of systemic risk, I’m sceptical. Hester’s argument seems to be that there is a “moral hazard” in creating a more formalised guarantee that the retail arms of banks will be bailed out by the state if they run into trouble. Hence, presumably, they are incentivised to act recklessly because there is no risk of them folding. My small politics-student brain struggles to imagine that retail banks will be rushing to purchase lots of toxic debt any time soon, leading me to wonder how reckless they’d actually be. I’ll assume I’m either naïve or that I’m missing something. Even then, however, the most obvious objection to Hester’s “systemic risk” claim is that he’s assuming that banks aren’t already aware that the government will bail them out if they run up against the wall. For all the tough talk, the reality is that last time the banks cried out for help, those in government took one look at what might happen if we let them fail, and abandoned any thoughts that we could go down that road. So this systemic risk already exists, and ring-fencing makes the cost of bailing out banks smaller.
On top of this though, retail banking and investment banking should be separated because they should have very different relationships with the state. Investment banking is naturally a private, commercial enterprise. It holds an ethic of profit-seeking and although maybe it could be considered “good” in the sense that any business is “good” (i.e. it generates wealth and employment) it provides no services which I’m prepared to consider as vital to society. Retail banks on the other hand perform essential functions as depositaries and intermediates, providing loans and channelling finance. Virtually all of us deposit money in retail banks, giving the state a mandate to act to secure the sector. We should be willing to guarantee retail banking and to support it (it’s not far from here to the argument that retail banks should be nationalised, but I won’t go there now) but we have no such obligation to profit-seeking initiatives. If this might lead to a risk that those running retail banks will become arrogant and reckless then this is something that needs to be addressed in some other way, possibly through more restrictive legislation, instead of an argument against separation.
We should ignore the bleating of conservative bankers, overly attached to the status quo, and pursue a legal separation of retail banking from investment banking. There are clear practical and ethical reasons to do so. The government should be credited for pursuing the right policies here.