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Analysis

Stand-alone future beckons

by Michael Lafferty, Deputy Chairman

Stand-alone future beckons

Britain’s banks could soon turn into financial holding companies with stand-alone subsidiaries for separate activities like retail banking and investment banking. Before long, assuming full transparency, arm’s length transfer pricing and a separate treasury for the retail bank, investors might demand that these new financial conglomerates exit activities that are not producing adequate returns. The result could be the creation of retail-only banks – the dream of many critics of today’s universal banks.

This is the prospect being considered by the UK government’s Commission on Banking, chaired by Sir John Vickers, which is due to report in September. The status quo, where all the activities are conducted within one centrally-managed business – typically under the overall management of an investment banker or corporate banker – is no longer an option, Sir John seemed to hint in a speech in January. The impression he left was that the universal bank is simply rigged to subsidise the investment banking business and the bonuses that go with it.

Discussing one of the arguments made in favour of universal banking, namely that it allows diversification of risks with the result that the probability of bank failure is lower than if retail and investment banking are in some way separated, Sir John rationalises: ‘It does not follow that retail bank failure is less likely with universal banking. In this respect universal banking has the advantage that a sufficiently profitable or well-capitalised investment banking operation may be able to cover losses in retail banking. But it has the disadvantage that unsuccessful investment banking may bring down the universal bank including the retail bank. In shorthand, in this simple setting, retail banking is safer with universal banking than with separated banking if and only if the probability that I saves R exceeds the probability that I sinks R.’

Britain’s banking leadership is not at all happy with a scenario of stand-alone subsidiaries for different forms of banking and is already fighting it tooth and nail, claiming that it will cost major banks billions in extra costs. Having faced down David Cameron’s coalition government on the highly contentious issue of bank bonuses – and threatened to move headquarters outside the UK if the government does not do their bidding – the banks seem to think that this is another battle they can win.

In one respect at least the UK banks have already scored a victory with the Commission, which is not convinced by the arguments for so-called narrow banking where only the entity taking retail deposits would be covered by a state guarantee. ‘What sort of institutions would have loans on their books under narrow banking? Maybe mutual funds – a kind of mass securitisation. But to ban the funding of ordinary credit by deposits could have considerable economic cost,’ says Sir John Vickers dismissively.

Meanwhile, Britain’s senior retail bankers are not saying anything in public, nor have they at any time during the current crisis. The official line at all senior management levels is that the only sensible way to run a bank is the universal banking way.

Out in the branch networks the attitude of Britain’s’ bank managers is typically different. They know that, in living memory, customers have never been more furious with banks and they appreciate that banks cannot be equally good at serving people, small businesses, large corporates, multinationals and governments. They are also very uncomfortable with the sales-driven culture mandated by head office as well as the vast price increases they have been ordered to impose on retail customers since the crisis began.

Most bank managers dream of the day when they will be able to provide customers with what they really need.

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