Last week’s moves by the Bank of England (BoE) aim to provide a ring-fence of protection and business continuity for retail banking units of large banks, effectively shielding them from problems their investment banking arms may face. They come at a time of increasing regulatory scrutiny in other developed markets.
The proposals of the U.K.’s central bank resonate in the U.S., where calls have gotten louder in the presidential election season to bring back the 1933 Glass-Steagall Act. Glass-Steagall also separated such banking activities, before being repealed in 1999. Also underway is a major European Union initiative to vest regulatory powers with the European Central Bank.
The BoE’s actions of October 15 were in the form of two consultation papers it released for public comment. The proposals sought to ensure “that ring-fenced banks have sufficient capital resources on a standalone basis, sheltering them from risks originating in other parts of their groups,” according to a BoE news release.
Effectively, from January 1, 2019, banks in the U.K. with core deposits greater than £25 billion ($39 billion) — broadly those from individuals and small businesses — will be required to ring-fence their core retail activities. The banks covered are HSBC, Barclays, Royal Bank of Scotland, Lloyds Banking Group, Santander UK and the Co-operative Bank.
The BoE’s proposals haven’t gone down well with the large banks, which have lobbied hard against it. They have the support of others who see stronger regulation as a threat to the status of London as an international financial center.
“The Tories (the U.K.’s conservative party) are in general saying that we should stop this re-regulation,” said William K. Black, University of Missouri-Kansas City professor of economics and law. “[That is] because they want to go back to the competitive race to the bottom on financial regulation, with the idea of preserving the City of London as a top financial center.” Black, who has extensive experience in financial regulation, is also the author of the 2005 book The Best Way to Rob a Bank is to Own One, published by the University of Texas Press.
“[The Bank of England’s ring-fencing move] should give courage to those who see that there is a public regulatory function to be followed that isn’t simply puppetry on behalf of major industry players.” –Peter Conti-Brown
Wharton professor of legal studies and business ethics Peter Conti-Brown said he is pleasantly surprised that the BoE “has stuck to its guns this far.” The current efforts to ring-fence retail banks in the U.K. began with amendments to the Financial Services (Banking Reform) Act in 2013. “The usual story of the political economy of bank regulation is that you get a crisis, you get a lot of populist enthusiasm for reforming the system, and then it will go quiet as major industry players start chipping away over time,” he said.
Black and Conti-Brown discussed the BoE’s moves and calls for stronger bank regulation in the U.S. on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
Test of Resolve
“We are now seven years removed from the [2008 financial] crisis; many electoral cycles on both sides of the Atlantic have happened, and the fact that we have a regulator that is sticking to its guns this far along is frankly quite impressive,” said Conti-Brown. “It should give courage to those who see that there is a public regulatory function to be followed that isn’t simply puppetry on behalf of major industry players.”
The big U.K. banks find the ring-fencing exercise too demanding on their resources. The operational separation of the banking units is expected to cost roughly £200 million per bank as a one-off cost, plus around £120m per year, according to a report in the U.K.’s Telegraph newspaper. HSBC, for example, faces costs of around £2 billion to split its retail and investment banking activities.
Jonathan Symonds, independent non-executive director of HSBC, explained his opposition to the House of Lords Economic Affairs Committee in a June hearing, also reported by the Telegraph. “I have 350 IT systems to separate,” he said. “It is consuming a very substantial amount of the productive capacity of the bank to implement this, when I really would rather be improving culture and customer service. This is a pragmatic issue.”
Calls for Glass-Steagall
Conti-Brown noted that in the U.S., politicians have called for a reinstatement of Glass-Steagall, including Democratic Party presidential candidates Martin O’Malley and Bernard (Bernie) Sanders. “[Even Democratic candidate] Hillary Clinton has made head-nods in that direction,” he said. However, it isn’t clear what version of Glass-Steagall the candidates are referring to, as it has undergone numerous changes over time, he added.
“One has to do the best [one can] on the regulatory side, and it is never going to be remotely perfect.”— William K. Black
Enacted as a response to the Great Depression of the 1930s, Glass-Steagall originally also sought separation of banking activities, but was progressively watered down before being repealed in 1999. “[Former Federal Reserve chairman] Alan Greenspan hated Glass-Steagall and he subjected it to 10,000 cuts in terms of regulatory waivers and loopholes and such,” Black said. “By the time it was effectively repealed in 1999 under Bill Clinton, there wasn’t a whole lot left of Glass-Steagall.”
Conti-Brown was doubtful about the wisdom of reviving Glass-Steagall. “I am skeptical that the discretion that would be given to regulators to make the exceptions [or waivers] will be durable,” he explained. He said he likes the U.K. model a lot more because it is simpler in that it focuses on the capital structures of the big banks. The investment banks cannot act as merchant banks or hedge funds by relying on the retail banking units within their groups, he noted. “They cannot rely on a depository base and … have to have separate justification.”
Shortcomings of Ring-fencing?
The BoE’s ring-fencing proposal has “enormous weaknesses,” according to Black. “Its central premise is that the two branches of the bank – the investment bank and the retail bank – will treat each other as if they have no affiliation,” he said. “That is never going to happen. That is a fiction. But the real key is the ring-fencing is under assault by the Tories, and there will be likely enormous exceptions that will be carved out of ring-fencing, and there is an effort to kill it entirely.” Conti-Brown, too, said that he is not betting on the implementation of the ring-fencing in 2019 in its current form.
Notwithstanding the challenges it faces, the BoE must persist with the ring-fencing proposal, according to Black. “One has to do the best [one can] on the regulatory side, and it is never going to be remotely perfect,” he said. “There will always be banks lobbying trying to gut the regulation. That separation worked well in the U.S. for many decades, and it would be a good rule not just for the U.S., but also for banks in general.”
