‘The most far-reaching reforms of British banking in modern history.’ That's how George Osborne called it in Parliament this afternoon, in a statement that contained few surprises. What the government's doing, in large part, is to follow exactly the recommendations contained in September's Vickers Report. But is that really as far-reaching, or as radical, as the Chancellor would have us believe?
Certainly, many of these reforms are encouraging: measures such as ‘bail-ins’ and ‘living wills’ should facilitate the orderly winding-up of insolvent institutions, and reduce the necessity for taxpayer bailouts. But other parts of the government's reform package are less convincing. For instance, additional capital buffers and reductions in maximum leverage rations — which go far beyond those being negotiated through the Basel process or in the EU — will be potentially damaging to the UK’s status as a global financial hub, without necessarily improving financial stability. Don't forget, Lehman Brothers and Northern Rock had significant core capital but still collapsed. It is more important to reform behaviour than increase capital requirements: bad decisions, much more than insufficient capital, caused the banking crisis.
And as for the much vaunted ‘ringfence’ separating retail banking from investment activity, that's unlikely to have as much positive impact as Osborne hopes, either. For one thing, ‘shadow’ banking institutions — which bypass these rules — are already significant in number, and are likely to proliferate thanks to the ringfence. Then there's the fact that this measure could restrict efficient capital flows, thereby inhibiting the ability of banks to provide those universal banking services (i.e. retail and investment) at which the UK excels. And heavy policing will add greatly to compliance costs, while various other restrictions associated with the ringfence may raise barriers to entry and lower the likelihood of exit — contrary to the government’s objective of promoting competition in the banking sector.
The general problem, at the moment, is that these reforms pay too much attention to making individual banks safe, and too little to making the system as a whole safe. In doing so, they skip over those system-wide phenomena — such as the over-reliance on short-term funding, or excessive asset price growth during booms — that lay behind the last crisis. Much more could be done in these areas, starting by giving the new regulators real bite. For all of today's fanfare, we still know precious little about the powers and freedoms that the Financial Policy Committee and Prudential Regulation Authority will enjoy. Until that's settled, then Osborne's reforms are, by definition, incomplete.