Vickers-Bank spat underlines UK’s toxic attitude to regulation

Sir John Vickers, the former chair of the UK’s Independent Commission on Banking (ICB), has written a searing critique of the Bank of England, accusing it of ignoring the Commission’s warnings about the low level of bank equity buffers.

His comments are, of course, correct that the Bank of England wants lower capital requirements than those he recommended as part of the ICB.

But the ICB, like the Parliamentary Commission on Banking Standards, the Banking Standards Board, and the Bank's own Fair and Effective Markets Review, was a piece of political theatre. It was the symptom of a system that has to be seen to be doing something about the bankers, whatever the rights, wrongs or reasoning behind it.

Bank of England governor, Mark Carney’s hints that even new regulations, like the Fundamental Review of the Trading Book, and revisions to credit risk approaches will not force up bank capital requirements suggest a move away from the “stuff them with equity” school of regulation.

Other regulators, including at the Basel Committee, have come to the same conclusions — new capital rules year on year have ground investors, bank treasurers and others down and hurt the recovery of the global economy.

This is a rejection of the idea that more equity funding doesn’t mean higher funding costs. Academics such as Anat Admati and Martin Hellwig have backed the concept, arguing that debt costs come down as equity levels increase — so that bank lending shouldn’t become more costly just because banks have higher capital levels.

But it doesn’t, in practice, seem to work like that. Forcing banks to raise capital by raising ratios or by tweaking risk weights seems to encourage banks to sell assets, cut new lending and overhaul their risk models.

GlobalCapital doesn’t know why this should be. We do not have any econometric or corporate finance models to play with. But it should be up to the academics to explain why the real world doesn’t match their predictions, not simply to reiterate their calls for more capital.

It’s true that once banks have boosted their capital levels, things seem to change.

The banks which moved furthest and fastest on capital are now on the front foot, able to win new business, hire, expand and lend.

Those that moved slowly have done rights issues at big discounts to book, and are struggling to slough off market fears that further rounds of fines or profit pressure could see them squeezed further.

Which is exactly why it isn’t helpful to have the fight over bank capital play out in public. It isn’t the absolute level of bank capital that restricts lending, it is the perception that banks will have to raise more capital, and that regulatory requirements are not final.

But in either case, more capital right across bank businesses is a smoother, more subtle instrument than trying to restructure banks by force.

The UK’s particular bank break-up regime is especially troubling though, because it includes ring-fencing, a concept without parallel in any other international regulation.

Every other regulatory body with a separation concept, like the Volcker rule in the US, or the bank structural reform proposals in Europe (with several national variations), carves out the bad stuff.

Ordinary banks are banned from prop trading, or sometimes trading in general.

Only the UK insists on carving out the good bits — making the retail parts of a bank bombproof.

Retail banks are perfectly capable of blowing themselves up without being attached to trading arms, but, with very good reason, most of the world regards this as less serious and damaging than an investment bank going down.

They’re simpler, less interconnected, and less systemic. Their earnings are more predictable and less volatile. Resolution rules, if they work for any firm, will work for retail banks.

Meanwhile, the retail ring-fence adds huge amounts of complexity. The banks each have different approaches to meeting the rules, but they’ve been shooting at a moving target since 2011. The final rules still aren’t out, and won’t be implemented until 2019.

The ring-fence is neither separation or unity — it requires formally separate corporate governance structures and restrictions on inter-group financing, but profit and loss can cross the divide.

Royal Bank of Scotland, for example, is putting corporate loans to UK companies (wholesome, good bank activity) inside the ring-fence, but booking the bond mandates that trail behind loans (nasty, investment bank stuff) outside.

Santander, on the other hand, looks set to try to keep as much as possible outside the ring-fence, to improve the structure of its UK funding. But the bank’s abandoned UK IPO is a testament to the troubles that banks face trying to adapt to the rules while keeping investors onside.

Ring-fencing might not be a terrible idea if it was the only piece of post-crisis bank regulation. In a brave new market-based world, investment banks could live or die by their wits while retail banks carried on processing payments and lending mortgages. But it isn't.

Banks have changed beyond recognition in many ways. They are stronger, less connected, more loss absorbing, easier to resolve, more liquid, and better supervised. They have multiple times their pre-crisis capital levels, with more recognition of off-balance sheet activities and cleaner group structures.

Set against this background, the last thing they need is a complex ring-fence rule, which adds little or nothing to safety, but, for political reasons, muddies the waters of bank resolution for the best part of a decade.