Bankers complaining about moral hazard? Is this a joke?
Satire expired for Tom Lehrer when Henry Kissinger was awarded the Nobel Peace prize. It died another death this week when Stephen Hester of the Royal Bank of Scotland and Bob Diamond of Barclays appeared before the Treasury Select Committee to argue against proposals to ring-fence retail and investment banking operations on the grounds that it would increase moral hazard.
Moral hazard, of course, is the phenomenon whereby businesses have an incentive to take crazy risks because they know the state will have no choice but to rescue them should they run into trouble.
Said Hester (right) to the committee:
“There is a great moral hazard if you create a protected beast that the government will support, while other parts of the banks are made more volatile as there is no way they would be supported.”
Diamond (left) agreed:
“An extreme view of ringfencing makes an implied [government] guarantee almost explicit.”
We are in a through-the-looking-glass world here. What Diamond and Hester failed to mention was that their giant mega banks – which both have liabilities roughly equal to the size of the entire British economy – are already guaranteed by the government because they are too big to fail. And that fact is the source of the abundant moral hazard the riddles the banking sector.
I’m not convinced that ring-fencing is an adequate solution to too big to fail. But one of the purposes of the ring-fencing proposal from Sir John Vickers’ Independent Commission on Banking is to reduce the level of moral hazard by making it less likely that the state would need to rush in to save a giant bank (as it notoriously did with RBS and Lloyds in 2008) in the event of another banking crisis.
Retail banks, which hold the deposits of ordinary customers, would be forced to hold more capital to make them safer. And being separately capitalised would, in theory, make them less likely to be contaminated by losses incurred by their parent company’s riskier investment banking divisions.
Also, the state could, in theory, move in to prop up the essential and ring-fenced retail function in crisis without needing to rescue the non-essential investment function. This won’t increase moral hazard in retail banking – that guarantee exists already; no government can afford to let ordinary high street savers lose their money. But it could, if applied properly, help to reduce rampant moral hazard in the banks’ investment banking divisions since traders would not be able to count on a government rescue, aimed at the retail bank, also covering their own losses.
I’m told by those who have had direct dealings with Hester and Diamond, both in the banking and policy making sectors, that they’re very intelligent men. If that’s the case, I can only conclude that they understand all this and that the purpose of their bizarre comments about moral hazard and government guarantees this week was to mislead.Tagged in: banking, barclays, bob diamond, Royal Bank of Scotland, Stephen Hester, too big to fail
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