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Bank reforms will keep Britain afloat

Independent Commission on Banking to publish proposals that will protect nation during any future financial crises

“Back off or the economy will get whacked,” warned an ugly chorus of bankers as the Independent Commission on Banking (ICB) approached publication of its final proposals. To their credit, the commissioners did not back off. Instead, they met head-on the demand for a cost-benefit analysis, and produced an answer to reassure any wavering members of the cabinet. The analysis yielded an “incredibly favourable” result, argued the chairman, Sir John Vickers. That was a key phrase . Consider it a message to government not to be intimidated by banks’ scaremongering.

It is true that £4bn-£7bn – the ICB’s calculation of the costs to the banks – is a large number, especially as we can guess that bankers will not be volunteering to surrender their bonuses. But context is everything: UK banks hold assets amounting to about £6 trillion. That does not imply that £4bn-£7bn can be lost in the wash. But it does mean that, if the ICB’s sums are correct, the cost of borrowing is not about to explode: the extra interest charged on loans should be counted in small fractions of a percentage point.

Then consider the benefit side of the ledger. The UK was almost bust by the 2007-09 banking crisis because it houses banks that are so big in relation to the size of the economy. The risk that the next banking crisis could sink the UK and its taxpayers had to be eliminated as far as possible. That is the rationale for going further than the new souped-up requirements by international regulators for banks to hold more capital, of better quality.

UK ringfenced banks will have to hold equity capital equivalent to at least 10% of their risk-weighted assets (more than the 7% level demanded by Basel’s boffins) and then top up their coffers with unsecured debt. Overkill, say the bankers. Rubbish: by historical standards – ie norms prevailing 20 or 30 years ago, before bankers saw that more leverage and more risk was the easiest way to improve returns on capital and pay themselves more – it is not excessive at all. Indeed, given the risk of colossal upheaval that would follow meltdown in the eurozone, there is a fair argument that the ICB has been lenient.

Ringfencing retail operations, the ICB’s most eyecatching idea, is intended to offer alternative protection. In fact, ringfencing is just common sense: it is absurd to run the risk that a retail bank, supplying basic financial infrastructure at home such as payment systems, could be brought to its knees by losses generated by an international investment banking division.

The counter-argument, that big universal banks bring stability via diversification, was dealt with neatly by the ICB. The ringfence will be “strong but flexible”. The latter quality will still allow a strong investment bank to throw capital over the wall to a retail division in need. Barclays, whose profits are still dominated by Barclays Capital, ought to be comforted by that fine-tuning, even it dislikes the idea of ringfencing.

Royal Bank of Scotland, on the other hand, will take little cheer in the ICB’s report. Deprived of the benefit of cheap funding from the retail division, RBS’s small investment bank may find life in the shark pool an unequal struggle. A strategic rethink looks inevitable. That’s bad news for any taxpayer still hoping to see a return on the £45bn invested in RBS shares: the price of those shares has to more than double just to get back to break-even. But it’s too late for regrets or compromises.

All in all, the ICB has delivered a route back to a safer banking system: more capital, fewer hidden subsidies for investment banks, and the hope of more competition in high-street banking. No, it’s not radical, or an instant fix, given that 2019 is a long way off. But it will be very hard now for the bank lobby to claim that the economy will be imperilled by reform or that the City will suffer a loss of competitiveness. That’s a big stride forward. © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds