The Bank of England and the US Federal Deposit Insurance Corporation have come out today with a joint plan to deal with major banking institutions that get into financial difficulty.
The solution is a sophisticated form of ringfencing. So if Megabank gets into a spot of bother in the next financial crisis, a regulator will step in to force shareholders and creditors to take all the pain (having their shares and indebtedness to the institution written down to zero if necessary). Megabank’s sound operating subsidiaries meanwhile could be transferred to a new solvent entity.
It seems to me that there are two big problems with this approach: Firstly, economics: From an investor point of view, what on earth are you investing in if you buy Megabank shares? An institution with assets of 100 if things go well, but only worth 50 if things go badly – how do you keep tabs and how do you value your stake? Not very easily I would suggest. Inevitably the cost of capital for Megabank will therefore skyrocket, which means higher costs for us all.
But the bigger issue is that the solution seems so naive. Back in October, Martin Taylor, former CEO of Barclays and member of the government commission reviewing the banking industry told the parliamentary commission on banking that, “a ringfenced bank would be as easy to supervise as a separate retail and commercial bank.”
Yet if regulation were so simple, we wouldn’t be in the mess we are currently in with our banking system.
One keeps hearing how part of the reason for the banking crisis was that we had a light-touch regulatory system. That’s as may be, but no one could claim that the regulatory regime established under the Financial Services and Markets Act 2000 and the myriad codes and orders it spawned was easy to understand or operate, and I doubt that the new system, whatever form it takes, will be any more accessible.
The ease or otherwise of regulatary oversight of course rather misses the point. When the ship hits the rocks, we can all pretty readily conclude that more should be done to avoid rocks in future. If only we had been able to spot the damn rocks in the first place. It is easy to be wise after the fact. Moreover, former Chancellor Lord Lawson suggested that there are huge risks that any ringfence would be permeated over time. The risk of the latter must be all the more acute you might think if the source of the next financial crisis is by its very nature unlikely to be seen until it manifests itself.
Taylor’s solution to this was that he said he would fully support enforcing a split of Megabank in future if any ringfencing measures failed. The joint paper published today by the US and UK regulators endorses this approach. So if Megabank faces a crisis again, solutions can include breaking it up, “into smaller entities.”
It’s like a pathetic plea from the errant school boy to be allowed one more chance to get his already late homework into the teacher after another extension. The time for more chances is surely gone. Ringfencing is a bad idea. The UK needs its own Glass-Steagall Act to split our commercial and retail banks into two.