Vickers’ UK bank ring-fencing will create more systemic risk
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Vickers’ UK bank ring-fencing will create more systemic risk

The Independent Commission on Banking’s report by Sir John Vickers on ring-fencing UK retail banks from investment banks will have dangerous consequences, say investment managers

 "The opportunity must be seized to establish a
much more secure foundation for the UK banking
system of the future
- Sir John Vickers, ICB

The financial system could face increased systemic risk, market participants argue, as the Independent Commission on Banking’s (ICB) latest report, led by Sir John Vickers, which aims to create a more “stable and competitive basis for UK banking in the longer term”, might lead to banks entering more unregulated and risky product trading.

“The proposed reform is a 20th-century solution to a complex 21th-century problem,” says Lothar Mentel, chief investment officer at Octopus Investments. “These reforms are a case of addressing the symptoms rather than the causes of the financial crisis and now if the reforms make business for traditional banks even harder, you generate even higher incentives for the investment arms to enter less-regulated markets, such as the structured credit markets, which is partly why we are in this financial crisis.”

He adds that there is a danger that it will increase the interest in the shadow banking sector again.

“If refinancing for banks becomes more expensive through an enforced ring-fencing, then there’s a greater incentive for institutions to avoid the traditional banking route once more and call on the structured credit markets for cheaper funding,” he says. “It would be dangerous for banks to feel incentivized to quickly dispose of any loans they make through these markets, in order to keep them off their balance sheets. Without a properly regulated and standardized structured credit market, such an outcome would be the exact opposite of what the ICB was tasked to achieve, namely preventing the next financial crisis, not sowing the seeds of it.”

The ICB published a number of proposed reforms on the UK banking system in a report, dubbed The Vickers Report, on Monday September 11, in order “to create a more stable and competitive basis for UK banking in the longer term and provide more than greater resilience against future financial crises and removing risks from banks to the public finances”.

The Vickers’ report says that banks would need to ring-fence their retail banking businesses from their investment banking operations by 2019, which it is hoped will lead to a “banking system that is effective and efficient at providing the basic banking services of safeguarding retail deposits, operating secure payments systems, efficiently channelling savings to productive investments, and managing financial risk.”

However, senior investment managers are quick to point out that the proposed reforms will have a detrimental effect on the banking system, rather than help pull it out of a financial crisis.

“The Vickers report may hurt lending, growth, employment, profitability and ironically increase risk,” says Gemma Godfrey, Credo Capital’s chairman of the investment committee. “Banks could be encouraged to take on more risk in their activities within the ‘ring-fence’ because of the likelihood of being awarded a bailout. Also, the flexibility banks have been granted in where to set the ‘ring-fence’ and which operations are classified as ‘retail’ could be misused.

“UK banks are already falling short of the lending targets set by Project Merlin. Net, not gross, figures show the level to be only just over 50% of the amount proposed. In addition, the increased cost of lending will not encourage this situation to change.”

Vickers admits that the cost of implementing changes, in order to ring-fence banks, will be between £4 billion and £7 billion.

Godfrey adds: “Over the last 10 years SMEs have provided over 80% of new jobs – with public-sector cuts, the private sector is relied upon to pick up the slack but lending growth to these firms has been negative since 2009 and the Vickers Report will only damage this further. It is estimated that the reduced growth outlook will cost the economy a further £1 billion to £3 billion.”

Download final ICB report (PDF)

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