Mark Littlewood: Sir John Vickers has asked the right questions, but few answers

On the face of it, Sir John Vickers was set a pretty simple remit: to head up a commission to recommend reforms to our banking system to prevent a repeat of the 2008 financial meltdown. But his interim report shows the confusions and contradictions that continue to beset discussion over banks.

How do we unravel the absurd situation by which we managed to privatise profits and nationalise risk? A whole range of things led to the banking crisis, but at its heart was the implicit promise of a government bailout.

As with any area of human activity, if you know your catastrophic losses are going to be picked up by someone else, you are likely to gamble recklessly. You get to keep your winnings and if it all goes wrong, the taxpayer steps in.

So, the centrepiece of reform needs to be to construct a way for banks to go to the wall, without public money being used to mount a rescue bid or the entire economy being brought to its knees. We need to find a method by which, as far as possible, banks can be wound up and fail in an orderly fashion in much the same way as any other business. The issues involved in banking are often more complex but the basic principle is the same. It is here that there is a tension in Sir John's interim report. He devotes a lot of his focus on trying to ensure retail banks do not fail rather than considering the more important question of how they can fail "safely".

But if banks can fail safely, we should not be too worried about this. And there is a danger that, if we make banks so safe that they never fail, competition will be inhibited.

Some would have liked to have seen Sir John recommending a complete separation between retail and investment banking. But he goes for the halfway house of subsidiarisation - or "firewalls" within a bank providing both investment and retail banking.

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The idea is that, by maintaining some division between the two, you make it easier for a bank to fail in an orderly rather than chaotic manner. But there are doubts here too. The suspicion remains that governments are loathe to allow investment banks to fail without intervening and why should a universal bank - providing both investment and retail functions - be obliged to arrange its affairs in this way if it can easily demonstrate to a regulator that it could be wound up in a satisfactory fashion should the worst happen?

Sir John has asked some of the right questions, but is still struggling to come up with many of the right answers.

l Mark Littlewood is director-general of the Institute of Economic Affairs


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