tony's blog

Monday, September 5, 2011

Let Battle Commence

So the lines are drawn. In one corner sits Confederation of British Industry director general John Cridland saying that the Government would be ‘barking mad’ to push forward with plans to ring fence UK banks given current grim economic conditions. And in the other corner sits the Chancellor George Osborne and Vince Cable taking Mr Cridland to task signalling their backing for the ring fencing plan.

It will be interesting to see what comes out of the final report to be presented by the Independent Commission on Banking (ICB) on September 12. Its provisional prescription for higher capital requirements, bail in provisions and a measure of separation between retail and investment banking has certainly shaken up the banking industry.

I can see both sides of the argument and whilst I agree that the timing isn’t ideal, my view is that short term pain is needed for long term gain and these suggestions are pragmatic and necessary.

Of course there will be huge amount of costs and disruption in setting up a new system with potentially higher funding costs which could ultimately get passed on to the consumer. It’s natural for banks to recoil against any change to the way they operate. So what will it mean for the mortgage industry in terms of supply of credit and cost of funds?

Difficult to answer and as usual there are two sides to this. By separating the investment bank activity from the ‘normal’ banking you take away the cross benefit to the retail bank from investment banking activities. How so? Investment banking allows banks to run a significantly leveraged model through trading and derivative activities which require significantly less capital than lending to you or me. The profits to be made are huge and across an integrated bank these allow the bank to maintain efficient balance sheet ratios and subsidise costs of lending activities.

So without these ‘subsidies’ the costs are likely to go up for the consumer at least in the short term. But you have to look to the future.  By taking away these other profitable albeit racier activities you remove a good degree of risk to banks.

The solution is to be realistic and pace its implementation. If we take the opportunity now to make these changes, over the longer term we will be left with a more robust financial system and ultimately it will be in the taxpayer’s interest.