Terry Murden: Ringfencing is not the panacea that banks’ critics like to think

The UK banks now face several years of implementing a complex ringfencing of their retail banking operations with separate capital reserves, boards and governance arrangements – all of which is in danger of distracting them from the equally important job of rebuilding their balance sheets and firing the economic recovery.

The banks are understandably unhappy that, as we forecast at the weekend, the reforms will mean a substantial addition to costs – by as much as £7 billion. The likelihood is that these costs will be passed on to customers so that the impact on profits is reduced and the price of banking rises for all of us. A demand that they hold greater reserves than required by the Basel III agreement puts pressure on their ability to lend.

The changes also raise the stakes in the UK banks’ competitiveness with their international counterparts who are not going through this process. Should the big companies choose to do business with their untouched European, Asian and American rivals as a result of the Vickers’ reforms, we may well come to question whether unilateral change was such a good idea. The reforms may also encourage the UK banks to consider shifting some of their activities overseas.

Change in some form was inevitable and the banks have already made some progress on these issues as well as volunteering some of the structural changes such as easing the ability of customers to switch accounts. But creating artificial firewalls is no guarantee against bad decision-making or uncontrolled excess which were the causes of the 2008 banking crisis. Northern Rock did not fail because there was no ringfence, but because it was lending money recklessly to homeowners at ludicrous loan-to-value rates. Ditto HBOS, which was not only pouring money into the mortgage market in a mad race with Northern Rock but was also fuelling an unsustainable boom in commercial property and M&A activity. Royal Bank of Scotland crashed because its boss refused to allow Barclays to get the better of him in the battle for ABN Amro and in the end saddled his company with massive toxic loans.

The Commission argues that had the ringfences been in place the banks would have been unable to undertake some of these activities as they would not have so easily accessed the wholesale markets, or at least customers and taxpayers would have been less exposed when the bubble burst.

To that extent, the ringfence helps take human fallibility, recklessness and self-interest out of the equation. It de-risks banking and introduces important safeguards. But it must not remove all aspects of risk which supports entrepreneurialism and it must not bind British banks in such a way that customers will be attracted to more flexible foreign rivals.

Ringfencing is preferable to a complete split as there remains the scope for one side of the fence to help out the other. On the other hand, RBS and Barclays, which have big investment banking operations, will be hardest hit and another air of gloom was said to have descended on Gogarburn yesterday.

At least those who called for the end of the status quo will get it and the ICB has not shifted from its hardline position on ringfencing since its interim findings in April.

Calls for a break-up of Lloyds have been ignored although the ICB has relented on its earlier proposal that its asset disposal programme should be enhanced. This is on condition that a strong “challenger” bank emerges – in other words it finds a merger partner for these assets – and that if these conditions are not met then a reference to the Competition Commission remains a possibility.

Aside from that, the ICB’s main concession is to agree a delay in implementation of the proposals to 2019 which looks less like kicking the reforms into the long grass and more of an acceptance that these changes will not be easy to introduce, particularly at a time when the regulatory regime is also changing and the debt and equity markets are fundamentally different to those that prompted the review in the first place.

Will the Vickers report lead to greater competition? Well, it might. But suppose Lord Levene’s NBNK acquires the Clydesdale and Yorkshire banks, successfully merges with the Lloyds assets, then acquires Northern Rock, as speculated. That would leave us with one less bank on the high street.

It might also encourage overseas banks to pick off what could become dangerously vulnerable British banks, leaving us with a banking system in foreign hands.

The unpalatable truth is that if we’re to get true competition then size matters, but size does not equate to more banks, only bigger banks.

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