Intellectual mush from the Vickers commission

Here’s what the original Coalition agreement said about structural reform of the banking sector (p9):

“We will take steps to reduce systemic risk in the banking system and will establish an independent commission to investigate the complex issue of separating retail and investment banking in a sustainable way.”

I find it hard to reconcile that promise with the fact that of the 208 pages of the interim report from the Independent Commission on Banking just two  (89-90) deal with the formal separation of retail and investment banking.

The overall report, chaired by Sir John Vickers (pictured), is an impressive piece of work. It reviews all the relevant literature. It dismisses the spuriously inflated figures put forward by the banking lobby of the annual cost to them of raising more capital (p94). It makes the point vigorously that a more stable economy is a benefit that must be set against the “cost” of a less leveraged banking system.

Yet when it comes to justifying the decision to stop short of recommending a full separation of investment and retail banking the ICB descends into intellectual mush.

The report argues:

“There may be economies of scope between retail and wholesale/investment banking which can be preserved within one financial group.”

But then in a footnote it points out that “most studies have not found strong evidence of scope economies”.

The report then claims:

“For customers who require both retail and wholesale/investment banking services, there may be advantages in being able to source these from a single provider.”

But then it admits that this claim came via the banks. What else would they argue? There’s no sign that the ICB has undertaken any of its own research into whether or not banking customers really want to do their business with too-big-to-fail megabanks.

The report implies that universal banking is good because it allows different parts of the bank to cross-subsidise each other:

“Full separation would remove all intrabank diversification benefits and so eliminate the possibility that one part of the group could save another part.”

But the ICB can’t have it both ways. If cross-subsidy of different banking operations is a good thing, why is the Commission recommending ring-fencing? Is it credible to claim that different departments of the same bank are both insulated from risk in a crisis, but also able to share collective benefits? If I was an investor in bank debt I’d take this cross-subsidy argument as an indication that I was investing in the group, not a subsidiary. Moreover, the expectation of cross-subsidy in difficult times from those running a particular department undermines one of the points of ring-fencing, which is supposedly to increase market discipline.

Finally, the report suggests:

“The costs of ring-fencing are substantially lower than those of a full split.”

Yet as far as I can see there’s no analysis of what these costs would be, or their order of magnitude (in contrast to the ICB’s impressive work on the costs of its favoured proposal of ring-fencing).

Paul Mason of Newsnight thinks there’s enough in this report to put a UK version of Glass-Steagall back into play. I hope he’s right but I’m not too sure. This reads to me like a report that has been given a political steer:  whatever the evidence says, stay away from a recommendation of a full separation.

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