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04/06/2012

Should we break up banks into two?

September 2011, the Vickers report in Britain reopens the debate on the separation of activities of retail banks and corporate & investment banks.

Since then, European politicians have addressed the subject from the perspective of investor protection against the speculation of CIB. However, the debate seems mainly driven by political pressure resulting from concerns in the public eye towards the banking system. This fear should be heard, but may not lead to risky decisions or even brutal ones.

Between extreme centralization and diversification on the one hand and disintegration of the value chain on the other hand, the range of possibilities is wide. The Vickers report - which is nothing but a moderated version of the Glass-Steagall Act (implemented in the United States in response to the crisis of 1929) - would impose solutions to British banks that seem from another time, moreover to solve a very different kind of situation. In addition, the results of the Glass-Steagall Act are ambivalent. Note that it was repealed in 1999 to end the lacking competitiveness of U.S. banks vis-à-vis European banks.

The Vickers report recommends indeed that the two activities should be isolated in a subsidiary company with a board of directors and with separate capitalization, aiming to isolate the retail activity in a security perimeter called "ring fence". However, the methods of separation remain unclear. According to the proposal, one-sixth up to one-third of the balance sheet should be isolated within the ring fence, corresponding to a ratio of one to two. Moreover, the reform program does not seem stable yet (2019 has been announced, at the earliest).

Numerous voices in Europe are heard in favor for an implementation of the proposed regulation. However, politicians seem to ignore - or deliberately overlook - several factors pleading in disfavor of separating the activities.

First of all, the cost of separation will be hard to bear for banks. If we take the principles of the Vickers report, the retail banking subsidiary would be subject to a capital ratio of 10%, or three hundred basis points more than the minimum requirement of the international Basel III agreement. Moreover, hybrid securities that easily can be mobilized should be added to this cushion.

For all major British banks, the verdict in terms of additional capital on the retail banking business could reach up to 20% of the assets.

Beyond the cost element, the principles of the Vickers report collide with the Basel III regulations that become effective from next year on. Moreover, the European Commission proposed the CRD IV for a strengthening of capital. In short, the European Commission, which wants to ensure consistent and homogeneous rules in Europe, carries the burden to create a mutual fund as response to banking crises that hit on the 27 member states. It seems that the proliferation of regulations and requirements is beginning to blur the ideas of politicians and regulators.

From a structural point of view, the lessons of the Glass Steagall Act do not plead in his favor. The two most illustrated victims of the crisis - the British bank "Northern Rock" and the American bank "Lehman Brothers" were operating on each single activity (the first was a retail bank and the second a pure investment bank), so completely in line with the principle of separation of activities. Conversely, banks that have best resisted the 2008 crisis are universal banks, with at the forefront the French banks and HSBC, symbol of the universal and worldwide bank . Indeed, Lawrence Summers, gravedigger of the Glass-Steagall Act , had already stressed that the universal banking model allows balancing the different activities according to the economic cycles.

From a business point of view, the separation would be even more difficult to understand. Investment banking activities should far from being reduced to solely speculation. To the contrary, they play an important role in financing activities of large companies, essential for the proper functioning of the economy. The CIB are also indispensable in their assistance to retail banks regarding hedges against fixed-rate loans, currency and refinancing. Separating the two activities is not as simple as compared to the last century.

Last but not least, from a cyclical point of view, the Vickers report could generate opposite effects than initially envisaged by destabilizing the retail banking business. In times of crisis when real estate activity falls down and unemployment rises, retail banking has already experienced negative outcomes. Today, within a context of increasing deposits due to the requirements of Basel III and the potential slowdown in mortgage activity for individuals, beneficial retail banking results are far from being guaranteed, quite the contrary. In the future, the investor that one wants to protect is therefore likely to pay much more for its credit due to the needs of the bank to maintain its margins while being deprived by techniques and products of the CIB (cover, swap , caps, floors ...).

There is no lack of arguments to defend the universal bank model. Once again, it remains necessary that real issues are raised alongside public arguments.

Sia Partners


And fifty basis points more on "systemic banks", whose definition is specified by Basel III by the acronym "SIFI" or "systemically Important Financial Institutions".

Directive of the European Commission addressed the Regulatory Capital (liquidity standards, definition of capital, counterparty risk, counter-cyclical measures, systemically important financial institutions, etc..).

Universal banks are financial conglomerates combining the various tasks of retail banking, financing and investment banking asset management and private banks. In particular, they combine the retail operations and investment.

Lawrence Summers was treasury secretary in 1999 when Bill Clinton weighed in favor of repealing the Glass-Steagall Act.

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