Government plans to ring-fence the banks – protecting retail banking from the riskier investment side – “fall well short of what is required”, a report has warned.
The Banking Standards Commission wants the government to “electrify” the fence so banks won’t try to “game” the rules.
That means regulators having the power to fully break up a bank if it does not follow the ring-fence proposals.
The bank reforms will go before Parliament early next year.
The Parliamentary Commission on Banking Standards, known as the Banking Commission for short, was asked by Chancellor George Osborne to study the draft version of the government’s Financial Services (Banking Reform) Bill.
This follows last year’s recommendation by the Independent Commission on Banking, which was led by Sir John Vickers.
Sir John concluded that ring-fencing was the best way to protect “core” retail banking activities from any future investment banking losses, such as were seen during the global financial crisis.
The Governments proposed bill hinged on three main aspects:
- ring-fencing or protecting retail banking
- ensuring that bank losses fall on bank creditors and not depositors or taxpayers
- making banks better able to absorb losses
But the government’s draft legislation was a watered-down version of the Vickers report which proposed quite a high degree of separation, said Andrew Tyrie, chairman of the Banking Standards Commission.
“The proposals as they stand [in the Bill], fall well short of what is required,” he said.
“What we’ve done with the Commission proposals is to put back some of that stiff separation into the ring-fence and then make clear that the key problem – that banks are going to be at the ring-fence all the time, which will be a nightmare for regulators – needs to be dealt with,” he told BBC Radio 4’s Today programme.
“And the way to do that is to say to banks ‘If you don’t try to game this ring-fence we won’t see the need to separate you.’
“Then they will have a massive incentive to get to a point where banks have certainty [not to be broken up].”
“That is why we recommend electrification. The legislation needs to set out a reserve power for separation – the regulator needs to know he can use it.”
Under the draft bill, ring-fencing would ensure that retail services of a struggling lender can be carried on independently and smoothly even if authorities let the rest of the group fail.
For example, in the case of a failing banking group, regulators could sell off its core activities – thereby maintaining continuity for depositors – while allowing the rest of the organisation to go through a bankruptcy process.
Secondly, retail deposits (but not pension liabilities) would be ranked ahead of the claims of other bank creditors in the event of a bank insolvency.
Thirdly, banks are to hold a sufficient capital buffer – as outlined by global regulators – which means that if banks do fail, losses can be absorbed by shareholders and other creditors rather than the taxpayer.
Ring-fenced banks would also be prohibited from carrying out a range of investment and wholesale banking activities, including the sale of complex derivatives, which are highly complicated contracts designed to hedge borrowers against certain risks but can lead to heavy losses if they go sour.
But in a concession, the Banking Commission proposal agreed to the use of simple derivatives, such as currency hedges, for banks within the ring-fenced body.
Under the draft legislation, the Treasury would have the authority to decide which banks ring-fencing should apply to, as well as specific activities to be undertaken within ring-fenced banks.
The Prudential Regulation Authority, which will become the UK’s regulator for deposit-taking institutions in April under the Bank of England, would have the power to ensure the ring-fenced bank to carry on with its business.
Mr Tyrie has also called on independent reviews of the effectiveness of the ring-fence proposals across all banks to take place at least once every four years.
-BBC
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