Glass-Steagall is back. Suddenly, since the Libor scandal, it has become respectable again to call for commercial banks to be split from investment banks, as the US famously did with its 1933 Act.
Leading newspapers, commentators and politicians such as UK opposition leader Ed Miliband have either called for a split or said they were open to the idea.
Longstanding supporters of a split feel galled. Why did these latecomers not support the idea in 2008-9, when there was a global political momentum to reform banks? At that stage, their voices might have tipped the debate in favour of the idea.
Instead, global regulators such as the Basel Committee decided not to change the universal banking model, but to make it stronger with higher capital and liquidity requirements.
The US edged a step back towards Glass-Steagall with the Volcker Rule, banning banks from proprietary trading, but with myriad exemptions and loopholes.
Crime and punishment
So why is the idea resurfacing now?
The main reason is emotional. People feel the banks “got away with it” after the financial crisis — only to be caught in another round of misdeeds. The Libor rigging revelations — which have only just begun — suggest to many that the culture of investment banking is irredeemably corrupt.
That is unfair to the many honest practitioners who strive for the highest standards in every area of the financial markets.
Yet just because some criticisms of investment banks are exaggerated does not mean that the industry is basically fine and should be left to its own devices. Still less does it follow that investment banks belong under the same roofs as commercial banks.
Bankers will groan in pain at the idea of re-opening the debate about Glass-Steagall now, when so much effort has already gone into re-regulating the banks in other ways. So will some politicians and voters, many of whom are tired of the crisis and want to move on.
There is much to be said for concentrating now on implementing the reforms already agreed, and on getting the economy motoring again, rather than opening a new regulatory battlefront.
But if the political storm over Libor — and other freshly uncovered abuses, such as the mis-selling of interest rate swaps to UK SMEs — gathers force in the coming months, then society may need a new way of lancing the banking boil.
Seeking the ideal
If the universal banking model is the right one, it needs to be justified more fully and clearly to society.
Proponents claim banks with diverse revenues from commercial and investment banking are more balanced and able to withstand turbulent times; that it helps corporate customers to have a one-stop shop for services from cash management to derivatives; and that retail customers benefit from banks’ ability to manage interest rate risks through financial markets.
The arguments for change are at least as weighty. Culturally, commercial and investment bankers were always at loggerheads — a battle that seems to have ebbed in recent years, largely because the investment bankers won. But when good times return, they would surely be happier apart.
The crisis has shown that taxpayers will always ultimately have to guarantee the integrity of the commercial banking system — even if bail-in rules eventually make bondholders bear some of the pain.
If commercial banks also do investment banking, taxpayers are on the hook for a whole lot of extra risks. It is hard to see how the UK’s Vickers plan for ringfencing retail banks will really protect a universal bank if wholesale funding markets decide its name is mud.
Defenders of universal banks point out that many commercial banks blew themselves up with ordinary lending, as in Ireland and Spain.
True — democratic societies are prone to bubbles because politicians always want higher asset prices. Regulators either turn a blind eye or have little power to lean against the wind.
Having big, mixed banks makes it even harder for regulators to spot banking risks before they become fatal. Thus, while everyone in Britain was fretting about leveraged finance in 2007, the worst problems were building up in structured credit, property lending and securitised funding techniques.
Supermarket or boutiques?
The one-stop shop argument for universal banks also deserves challenge. Simpler commercial banks — like many smaller banks today — could buy risk management services from investment banks on an arm’s length basis.
Corporate clients could also shop around, without being constrained to give derivative or bond mandates to banks that have lent them money.
Loan pricing would surely rise if commercial lenders had no ancillary business to look forward to — but that is something every self-respecting loans banker has been calling for, for years. Banks say they want credit to be “properly” priced, in a way that reflects the genuine risks and costs.
The private placement market, in which insurance companies provide illiquid debt to corporate borrowers without hope of ancillary goodies, shows that such purely priced debt need not be uneconomic.
There are many more arguments on both sides, which have not been fully examined. In 2008-9 the idea of fundamental change to the banking model was too quickly brushed away, as the authorities feared to challenge already shaky banks.
Whether it happens now, amid the political heat of a new banking scandal, or is deferred to a calmer time, reviving Glass-Steagall deserves proper consideration.