City faces bank reform: structural changes needed to ensure financial stability

By Angeli Datt

On Monday 12th September, the Independent Commission on Banking (ICB) chaired by Sir John Vickers released its long-awaited report on bank reform. The Chancellor George Osborne has already promised to create legislation based on the recommendations of the report, such as ring-fencing retail banking operations and holding 10% core capital. The ICB has estimated that these reforms could cost Britain’s banks £7 billion, but with the aim of preventing a repeat of the financial crisis.

The effect of these reforms on the City, such as the potential loss of competition and capital during a time of slow growth, has critics questioning the government’s decision to pursue structural reforms right now. However, the commission was created in June 2010 with the aim of promoting financial stability and reducing the risk of bailing out banks again, which at one point had banks owing the government £1.162 trillion. The coalition has come out in full support of the Vickers Report and its proposals that would not fully be implemented until 2019 anyway.

The decision to require banks to ring-fence their retail section was made with the aim of reducing the cost to taxpayers if there was the need for another bailout. Banks such as Lloyds TSB, Northern Rock and the Royal Bank of Scotland were saved because of the damage their collapse would have on the economy, and the loss of billions in deposits. The aggregate balance sheets of UK banks is more than £6 trillion, or over four times the GDP of the UK, thus the potential cost of another bailout means that structural reforms need to be undertaken.

The Vickers report recommends that banks be allowed to decide what is placed inside the ring-fence, but believes the implementation of a ring-fence is better for the industry than a total separation of high street operations from global investment activities. Described by Vickers as a ‘strong but flexible’ approach, there is the hope that these reforms will also stimulate the movement of capital from retail banking back into the domestic economy rather than international investments.

Surprisingly, the chief executive of Barclays Bank, Bob Diamond, came out in favour of the report, which has led many news outlets to conclude that the banks succeeded in watering down the ICB’s recommendations. Though there is speculation once again with the release of the commission’s recommendations that HSBC might move back to Hong Kong, the bank has warned that its domicile review should not be taken out of context. Barclays and HSBC are two of the banks that would be the hardest hit by the passage of this legislation.

As a nation split between the need to protect the country from the risk of excessive bank liabilities and the overreliance on the banking industry for economic growth, this report is a step in the right direction. Without over-regulating or suggesting the break up of the banks that are so crucial to the British economy, the report has outlined structural reforms to a system that clearly failed in 2007. The rating agencies have said that British banks will not face downgrades, thus staving off for now any immediate action in the industry. Shadow Chancellor Ed Balls has also welcomed the report, and apologised for the role the previous Labour government played in the crisis, adding cross-party support.

The Vickers report calls for a higher capital protection percentage than the international standard Basel III rules of 7%, and the British are leading the way in banking reform. This summer has witnessed a great deal of political infighting that has got in the way of effective leadership on economic issues, such as the Eurozone crisis and US debt-ceiling crisis. Though the recommendations in this report will not be fully implemented until 2019, the recognition by the coalition government of structural change is a welcome acknowledgement of the need for stronger responses to the financial challenges faced today.

It remains to be seen if these reforms can help prevent another taxpayer bailout, or even another financial crisis, but the government’s openness to structural reform is a refreshing way to end this summer’s political fighting.

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