Having published its final report, the Independent Banking Commission has recommended that the retail operations of UK banks be ring-fenced from their investment operations. Given the Commission’s interim report, this was of course expected and tacitly accepted by most within the banking sector. Despite any indignation they may publically express, the banks are acutely aware of how this proposal stops short of their worst fears being realized – an actual split of their retail and investment operations and a break-up of so-called universal banks that include both services.
The Commission was established by the Government in 2010. The Commission was asked by the Government to ‘consider structural and related non-structural reforms to the UK banking sector to promote financial stability and competition’. Given it was established against a backdrop of public anger and opprobrium for the banking sector, the banks were understandably concerned that the Commission’s proposals could signal an end for the light-touch regulation they have been subject to and introduce a new era in UK banking with their retail operations being split from their riskier investment operations.
The banks soon began lobbying the Government for conservative reform (no pun intended), arguing that the contrary would compel them to relocate their operations abroad, a warning echoed by the British Bankers’ Association (BBA). The BBA recently argued the schedule for any reform should allow ‘the banks to finance the recovery first, pay back the tax payer next, and only then turn to further regulatory change’. Considering the Commission has proposed its recommendations be implemented by 2019, it’s fair to say the BBA’s aim to delay the reforms being implemented has been achieved. Whether the message be to disregard, limit or delay any forthcoming reform, it is clear that reform is not welcome by the banking sector.
The Commission’s interim report was met by some suggestions that it (and the Government) had succumbed to lobbying by the banking sector in declining to propose a split of investment and retail operations. Nonetheless, stopping short of this was always on the cards. Therefore it should not have been met with much surprise. With a Conservative-led coalition, traditionally a friend and ally of the banking sector (and no fair-weather one at that) and intense lobbying, such radical reform was always unlikely. And while the Labour party in opposition may argue they would seek far-reaching reform, that certainly wasn’t what they sought while in power.
Putting the Commission’s proposals into context, they are relatively speaking a significant departure from current arrangements. A separation, albeit not a split, of retail and investment banking operations is arguably a step in the right direction. It is also a move that will cost the banking sector – according to the Commission, ‘a plausible range for the annual pre-tax cost to UK banks of the proposed reform package is £4bn-£7bn’. That’s a sizeable sum but in relation to the total revenue generated by the banking sector, it’s one they can easily take on the chin. Consequently, in a broader context, the reform is actually reasonably moderate in its impact on the banks and how radical it actually could have been.
Playing out the scenario of more significant reform to the banking sector resulting in a split of retail and investment operations, what would the consequences be in practice and how would the banks’ threat of relocating their operations abroad manifest itself? Firstly, it would create a less opaque situation when it comes to banks and the accompanying risk they carry. Retail banks would be retail banks and investment banks would be investment banks. Pretty simple really. That in itself would mitigate the risks associated with retail banks and given the services they provide, rightly so.
Some commentators have argued that such reform would make the UK a less competitive and less hospitable environment for the financial sector. That might be an assumption or just scaremongering by the lobbyists. As an aside, amidst their indignation, a split of banks’ operations might also bring some humility to a sector where it’s patently void of such sentiments.
Secondly, should any bank decide to relocate, they would still maintain a physical presence in the UK, in many cases broadly doing business as usual. Instead, where banks’ corporate headquarters are based in the UK, this would no longer be the case. This would of course have an impact on the tax receipts from the banking sector.
Despite the aggressive tax avoidance schemes such as those operated by Barclays Capital and uncovered by the Guardian in 2009 (the documents uncovered were subject to an injunction by Barclays – somewhat of an empty victory given they were already online and raised in the House of Lords by Lord Oakeshott using parliamentary privilege), tax paid by the banks amounts to a not-inconsiderable sum collected by HMRC. Not to mention, there is also the income tax of banks’ employees that adds to their contribution. Further antagonising the banks beyond the unpopular banking levy and the targeting of bankers’ bonuses therefore cannot be taken lightly.
If banks were presented with unfavorable reform, would they relocate their corporate headquarters from the UK en masse? While some arguably might make the move, it’s unlikely they all would. In fact, two of the UK’s biggest banks, Lloyds Banking Group and RBS, are part-nationalized. It’s therefore reasonably safe to say that they aren’t going anywhere.
Furthermore, for those banks that might consider relocation, they would have to reflect on the opportunity cost of doing so. Relatively speaking, the UK is certainly favorable to banking with the extent of regulation it offers. With the current Conservative-led coalition, bankers can also be sure to find a sympathetic ear or two in Government.
Banks having the ear of politicians is more apparent in London where the banks’ presence is highly visible within The Square Mile. Bob Diamond, Chief Executive of Barclays, is an advisor to Boris Johnson, the Mayor of London, and also serves as a trustee of the Mayor’s Fund for London. This relationship has surely been beneficial with the Mayor being vocal in his calls for the Government to go easy on the financial sector given its importance to the London economy.
On reflection, the banks’ threat to relocate, albeit credible and one which would affect the UK, therefore isn’t a foregone conclusion.
That should have emboldened the Commission to further consider making a recommendation akin to the Glass-Steagall Act. The Glass-Steagall Act was US legislation created in 1933 against the backdrop of the Great Depression with the aim of mitigating the likelihood of the events that had ensued reoccurring. This was the UK banks’ biggest concern of the Commission’s recommendations. However, surely there hasn’t been a better time to justify and evidence the need for such reform?
The Act prohibited retail and investment operations being provided within the same bank. In doing so, it separated the risk of investment banking from what should have been a lower-risk environment for retail banking. Retail banks could no longer underwrite stocks and bonds, reducing the risk in relation to retail customers’ deposits. Conversely, investment banks could not accept deposits from retail customers.
With the hindsight of a banking crisis that resulted in bailouts and nationalization of financial institutions around the world, Glass-Steagall-esque legislation appears to be a simple yet effective idea. The Act was repealed in 1999 and gave the green-light for retail and investment banking operations to once again be comprised within the same institution. Many have argued its repeal was in part responsible for the banking crisis in the US that occurred within the subsequent decade.
There is also the question of how true the notion of ‘too big to fail’ would be had Glass-Steagall been in place. Considering the collapse of Lehman Brothers, it could be argued that had its operations included retail banking, the US Government may have felt compelled to provide a bailout package rather than take the course of action that led to its demise.
The proposal to ring-fence retail banking isn’t the only recommendation of the Commission’s final report but it is the most significant. The banks are already arguing that ring-fencing will cost them but deep down they’re relieved that cost won’t be a split of their operations.
It would be wrong to suggest a split of the banks’ operations a la Glass-Steagall would have eradicated the risk and culture of bankers that contributed to the banking crisis. Nonetheless, it would have further mitigated that risk beyond the ring-fencing proposed by the Commission.
The banks’ opposition and lobbying to avoid a split of their retail and investment operations has successfully avoided their biggest fears. The opportunity for more meaningful and far-reaching reform within a sector that clearly needed it was both viable and achievable via the Commission’s reforms. Yet the balance of power between the banking sector and the Government probably meant it was never really on the cards.