Vickers’s bank reform flaws.

The basic and flawed principles underlying Vickers’s “ring-fence” proposal are in a section of their final report headed “Structural reform: principles.” It reads:

“A number of UK banks combine domestic retail services with global wholesale and investment banking operations. Both sets of activities are economically valuable while both also entail risks – for example, relating to residential property values in the case of retail banking. Their unstructured combination does, however, give rise to public policy concerns, which structural reform proposals – notably forms of separation between retail banking and wholesale / investment banking – seek to address.  Investment banks can fail. Retail ones cant be allowed to.

Plus they say:

“The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.”

Now the first problem there is the sentence “Investment banks can fail”.  That is, there are big question marks over whether large investment banks should be allowed to fail: witness the argument over whether Lehmans should have been allowed to fail.

Second, separation a la Vickers involves having banks or bank departments in the retail half of the industry accepting deposits and lending those on to industry, mortgagors, etc (their p.234). Thus depositors’ money is not 100% safe, thus government still has to stand behind, i.e. subsidisise  those banks. But that contradicts Vickers’s claim (above) that “risks should not sit with taxpayers”. (The report itself (p.233) admits that even banks under their system are not 100% safe: they talk about making it “easier to sort out both ring-fenced banks and non-ring-fenced banks which get into trouble…”).

So how do we put right the flaws in Vickers? Well it’s easy. Do the split a different way, and as follows.

Allow any entity (household, firm, etc) to have a 100% safe government backed account. But nothing is done with that money (or possibly it’s invested in short term government debt) ergo it really is 100% safe. So there’s no risk to taxpayers there.

As to those who want their money invested or loaned on, they (and not taxpayers) carry the risk. And that in turn means those depositor / investors’ stake amounts to a share rather than a deposit measured in a specific number of pounds or dollars. And that in turn means the relevant bank or bank department cannot go bust because if silly loans are made, all that happens is that the value of the shares drops. The bank or bank department does not go insolvent.

And the latter system is called “full reserve banking”.

Conclusion: full reserve achieves the aims that the Vickers commission set itself, whereas Vickers’s own “ring-fence” fails to achieve those aims.