How the UK wants to deal with its biggest banks

By Felix Salmon
June 14, 2011

In the Republican presidential debate last night, there was unanimity on most issues, including the new orthodoxy on the right that bank regulation — like any other regulation, for that matter — is a Bad Thing, and a sign of the government overreaching. It’s important to remember that this is not the way that right-wing parties behave elsewhere in the world. Consider for instance the UK, which seems to be cracking down on banks in a manner which would make even Barney Frank blush:

Britain’s biggest banks will be forced to put a firewall around their retail operations, the chancellor will announce on Wednesday at the Mansion House…

This was the central proposal made by the Independent Commission on Banking (ICB) in its April interim report…

By putting retail banking into a separate legal subsidiary, ring-fenced from the trading and investment banking activities of a big bank, the vital parts of our giant banks will be less exposed to danger in a crisis.

The idea is that the retail banking bits of Barclays, HSBC and Royal Bank of Scotland will have more capital to absorb possible losses…

The ICB’s interim report suggested a minimum capital ratio for retail banks of 10%, which Mr Osborne is understood to support, although he won’t quote any precise number for the new minimum capital ratio.

A source close to the chancellor said there was “nothing sinister” in Mr Osborne’s reluctance to quote a particular number for how much capital above the international floor should be held by British retail banks. “Ten per cent is certainly the right ballpark”, he said.

This is bold and welcome thinking. From a regulatory perspective, banks have good profits and bad profits. Bad profits are the ones coming from risky structured products and leveraged trading desks; good profits are the ones which come from the lending investment capital to individuals, small businesses, and large companies. State-insured deposits should be use to fund good businesses, not risky and speculative businesses — as should any access to central bank liquidity windows.

So if you’re not going to break the big banks up, then the next best thing is to force their riskier arms to operate outside the protective walls of their too-big-to-fail retail operations. And the retail operations should be as bankruptcy-remote as possible, with extremely stringent capital requirements on the order of 10% of total assets.

Now the 10% figure, although it sounds tough, might not be quite as harsh as it seems at first glance: I’m sure that it’s based on risk-weighted assets, for one thing, and so the details of the risk weighting will be very important. And I suspect that banks might be able to put all manner of capital into that 10% bucket, beyond tangible core equity: the UK is likely to allow them to use their beloved CoCos, for starters.

All the same, Britain’s politicians are thinking constructively about how to rein in the more dangerous tendencies of its biggest banks. The same can’t be said, sadly, of their U.S. counterparts. There are bank regulators at the Federal Reserve and elsewhere who are trying to put in place higher capital requirements for systemically important financial institutions — but those will be negotiated on the international stage, in Basel, and will phase in very slowly. The UK policy, by contrast, could simply be implemented unilaterally, and would make that country significantly less prone to systemically-dangerous bank crises. Just don’t think for a minute that it’s likely to be replicated here.

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