Alf Young: A reluctance to ring-fence the city

Others in a shuffling queue, settling billion-dollar-plus plea bargains with regulators on both sides of the Atlantic on a succession of post-crash delinquencies, from fixing the Libor inter-bank lending rate to facilitating money laundering on a grand scale and mis-selling payment protection insurance.

All struggling to rebuild balance sheets against a tide of public resentment and a deeply disgruntled investor and customer base. Pre-crash Titans left with barely the corporate lungs to blow up a few festive balloons, let alone breathe new life into the flat-lining economies they are supposed to be lending into.

The debate about what to do about our too-big-to-fail banks carries some curious echoes of how another debate – about how to curb illegal immigrants – developed in this year’s US presidential election. Part of the price hardline Republicans extracted from Mitt Romney to make him their candidate was a pitch to electrify the border fence between the United States and Mexico.

In the UK this week the parliamentary commission on banking standards came up with the same remedy, as its price for supporting the Westminster coalition’s draft banking reform bill. The bill’s central innovation – ring-fencing retail from wholesale and investment banking – will only work, argues the commission, if banks know there is a heavy price to be paid if they set their brightest talents on the task of finding ways over or under that obstacle.

“For the ring-fence to succeed, banks need to be discouraged from gaming the rules. All history tells us they will do this unless incentivised not to. That’s why we recommend electrification. The legislation needs to set out a reserve power for separation. The regulator needs to know he can use it,” explains commission chairman, Andrew Tyrie MP.

No smoking corpses of investment bankers, then, strung out along fence wire down Bishopsgate and other moneyed City of London thoroughfares, the way Republican hardliners wanted to curb itinerant Hispanic fortune seekers. Rather the current Tyrie and his commission colleagues want to see surging through the banking ring fence proposed by the Westminster government is one that says: breach this and we’ll break you up completely.

The whackier elements of Tea Party fundamentalism didn’t do a great deal for Romney’s chances of reaching the White House. Would the commission’s idea of an electrified ring fence in UK banking fare any better? If generation after generation of bankers can’t resist testing the regulatory limits set for them, why not do that separation right now and make it impossible for big banks to shelter the utility of retail banking under the same corporate umbrella as what, post-crash, has come to be known as the casino side of the business?

In the proposed bill, George Osborne and the Treasury have already watered down the original ring-fencing proposals from the Independent Commission on Banking (ICB) chaired by Sir John Vickers. That suggests they will be reluctant to embrace the kind of electrification proposed by Tyrie’s parliamentary commission. One wonders why it didn’t just go for broke and call for full separation of the two forms of banking now.

There are a growing number of influential voices arguing for just that. The retiring governor of the Bank of England, Sir Mervyn King, told Tyrie’s commission: “I have made no secret of the fact, and I have spoken about it for five years, that I have always felt that total separation was the right way ultimately to go.” King also noted it had been at first “a lonely and difficult furrow to plough”. Professor John Kay told the commission: “I have thought, and in some ways I continue to think, that the effectiveness of ring-fencing would be demonstrated by whether Barclays wanted to split itself up.”

But even King and world-weary-sounding Kay are prepared to accept some more limited reform now rather than end up with no reform at all. The problem, as Kay pointed out, is many more bits may get knocked off the whole loaf before a deal is finally done. The parliamentary commission could have taken a harder line.

But it too knows that the senior decision-making in big banks is now dominated by those from an investment banking background, men – and the occasional woman – steeped in the culture of proprietary trading, where the bank doesn’t just service the needs of its clients, but is in direct competition with them in some of its most profitable trading activities.

The so-called Volcker Rule, being implemented in the United States through the Dodd Frank Act, essentially outlaws proprietary trading by banks and makes that the dividing line. But none of the reforms being proposed here or in mainland Europe, make that specific distinction. The issue here is where to place the fence between retail and corporate banking activities as a whole and which activities should be allowed to go on, on both sides of the ring fence.

That fundamental choice carries big consequences. Investment bankers already dominate the top layers of executive power in UK based banks. And as Paul Volcker himself pointed out to the Tyrie commission, that has major cultural consequences. “If a bank is allowed to do proprietary trading, or proprietary investments, you will not have a culture you like because, de facto, you are then competing with the client, and it is a lot easier to do proprietary work than it is to do client service. The brightest and best ... will gravitate to the proprietary activity and we end up where we have ended up… with bankers who do not always understand right from wrong.”

It’s a sobering prospect. The Tyrie commission was principally set up, in the wake of the Libor scandal, to consider banking standards. That’s just another word for banking culture. And if Volcker is right that culture could emerge, even after the coalition’s reform bill becomes law, as one where those in charge a generation from now still won’t know right from wrong.

One Scottish banker, who appeared as a witness before Tyrie, recalled a time in Bank of Scotland when losing capital was regarded as “a mortal sin”.

Well, since 2007 assorted UK banks have lost vast amounts of capital. Mortal sinning has been committed on a gargantuan scale. The UK government, with its Vickers-lite bill, still seems in thrall to the banking lobby.

Andrew Tyrie pushes separation as a reserve power and talks of taking further evidence in the new year on whether some kind of Volcker Rule may be “appropriate” here. Might it take yet another banking crisis, a few years down the tracks, and another prospective taxpayer-funded bail-out before we see real lasting reform?