Vickers’ missing cost-benefit analysis
Why did the Vickers Commission reject a full separation of retail and investment banking? After the interim report in April which failed to offer a convincing or detailed explanation for why this option was ruled out, I had high expectations from the final report.
I’m afraid they have not been met.
Here’s what Vickers says in the final report on why it did not recommend a Glass Steagall-like division of banking functions:
“First, total separation could have higher economic cost than ring-fencing in terms of efficient intermediation between saving and investment, diversification of risk, and customer synergies. Second, it is not clear that total separation would make for greater financial stability. It would remove a channel of contagion risk from investment banking to retail banking (and vice versa), but would preclude support for troubled retail banks from elsewhere in banking groups. Third, total separation is harder to enforce under European Union law inasmuch as (absent competition issues) universal banks in other member states would remain entitled to own UK retail banking operations.”
So let’s take those objections in order.
First, Vickers argues that there are economic benefits from the universal banking model since banks are able to “diversify” their risk better and also to serve the needs of their customers more efficiently.
Strange then that, later in the document (p137), Vickers notes:
“The belief that universal banks offer diversification benefits is held by a number of market participants, including some universal UK banks, but the available empirical evidence is mixed.”
The report also points out (p275) that:
“There is also evidence that diversification in general, and the addition of investment banking activities to retail banking activities in particular, engenders greater systematicity in banks, which may be bad for the system as a whole.”
“Systematicity”, in English, means that universal banks could be more dangerous for the economy in a crisis than less “diversified” banks.
Vickers makes these points to support its recommended system of the ring-fence. But it fails to acknowledge that they also undermine one of the fundamental arguments about the economic benefits of universal banks.
What about the benefits to banking customers of giant banking supermarkets?
Vickers asserts that (p276):
“[Universal] banks are able to fund illiquid assets with short-term liquid liabilities because different customers will typically want to withdraw funds at different times…The production of liquidity in this fashion is socially valuable.”
But then, acknowledging that ring-fencing will result in a reduction in a bank’s ability to give customers what they want in this way, Vickers states:
“The associated costs are likely to be small…And the calibration of the new Basel liquidity requirements suggests that there was too much liquidity transformation conducted by banks in the run-up to the crisis in any case”
The problem is that this undermines the whole notion that it is terrifically useful for corporate customers to have universal banks.
The final two points Vickers makes about the universal banking benefits are the weakest of all.
So a full split would prevent an investment bank propping up its retail arm in a crisis? Surely this is a good thing as it would concentrate the minds of the executives of the retail division. They wouldn’t expect to be bailed out by the wider group if they made foolish loans.
Finally, Vickers raises a legal objection to a full split. It would, apparently, be hard to prevent universal European mega-banks setting up shop here in Britain and taking retail deposits. But we have a clear interest in ensuring that all banks that take deposits from British citizens are absolutely safe. If we do not believe they are, we must prevent them doing so. This is surely the lesson of the Icesave fiasco. If European law does not allow us to prevent that happening again, the answer is to work to change European law, not to shy away from reforming our own banking sector properly.
The Vickers report is impressive in its rigorous cost benefit analysis of ring fencing. But what it has lamentably failed to do is perform such an analysis of a full separation.
What I hoped to see from Vickers was an attempt to quantify the economic benefit of universal banking – both for customers and wider society – and also to estimate the costs of getting rid of it. But it’s simply not there.Tagged in: banking, diversification, Icesave, Sir John Vickers
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