British Policymakers Pursuing 'Half-Measure' In Trying To End Too Big To Fail
WASHINGTON -- British proposals to force large banks to separate their riskier trading operations from their retail units go further than what U.S. policymakers ordered when revamping their financial system, yet still fall far short of truly ending the perception that megabanks are too big to fail, experts say.
The Independent Commission on Banking, a panel formed at the urging of the government last year to recommend ways to increase the stability of the British banking industry, suggested in April that lenders should isolate their basic banking operations into separately capitalized subsidiaries within the larger bank. This would make it easier and cheaper for regulators to wind down failing firms while protecting retail and business deposits, the panel argued, and more expensive for banks to engage in capital markets activities like trading in derivatives.
Britain spent more than 65 billion pounds in taxpayer funds rescuing Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc during the financial crisis.
Policymakers, trying to avoid a repeat scenario, have latched onto the idea of a subtle separation of banks' retail and investment units. Chancellor of the Exchequer George Osborne backed the proposal last month during his Mansion House speech.
But that idea, while it has caused an uproar among British bankers for the costs it would likely impose, barely takes a stab at ending so-called "Too Big To Fail," say experts like Simon Johnson, a former chief economist at the International Monetary Fund.
"The question is what's the size you're left [with] and are you afraid of them failing," said Johnson, a professor at the MIT Sloan School of Management and a member of the U.S. Federal Deposit Insurance Corporation's systemic resolution advisory committee. "By itself, [ringfencing] is not going to do much."
Johnson reckons the banks will still be too big, and policymakers will remain too scared to let them fail.
While banks would be forced to hold a bit more cash as a buffer against extreme losses -- a result of having to raise more capital for the separate subsidiary -- they would ultimately remain nearly as large as they are now, and would not hold nearly enough capital to protect taxpayers from having to rescue them in case of failure, experts argue.
"In principal, this is a perfectly reasonable thing to do," said Richard Portes, president of the Centre for Economic Policy Research and an economics professor at London Business School. "But it doesn't strike at the essence of the problems that caused the crisis or try to prevent future ones."
"The banks will still be very, very big -- it will be just as big as before -- and with that comes not just 'too big to fail' but 'too big to manage' and 'too big to cope with politically,'" Portes said.
Johnson recommends big banks be broken up. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, an arm of the U.S. central bank, says the same thing, as do his counterparts in St. Louis and Dallas. Hoenig says that financial firms that take deposits, which enjoy taxpayer backing, should not be allowed to leverage that support to engage in riskier activities like trading for their own account.
Last year, the U.S. passed a financial regulation law known as Dodd-Frank that aimed to end the perception that some firms are so big that policymakers would not allow them to fail. One of the law's provisions mandates that banks reduce trades made for their own account, while another calls for some of banks' derivatives activities to be organized within a separately capitalized subsidiary.
Regulators are at work defining key terms that would govern such moves.
The British independent commission, led by former Bank of England chief economist John Vickers, could have gone further, particularly given the size of the banking industry relative to the economy.
However, the commission dismissed ideas like Johnson's as "radical" in its interim report, released in April. Instead, the Vickers panel pursued "more moderate measures."
"You can't get half-pregnant in this game," said Amar Bhide, a professor of international business at the Fletcher School of Law and Diplomacy at Tufts University and a former proprietary trader at E.F. Hutton.
"It's not enough to have a ringfenced subsidiary; I think the ringfenced entity ought to be free and clear on its own accord," Bhide said.
Bhide, like Johnson and Hoenig, supports cleaving off capital markets units from retail banks.
"These things are spaghetti-like creatures, where no one quite knows who owns what, what the obligations are, and to whom and by whom," Bhide said. "People have no clue from the outside -- including, I suspect, the regulators -- what a mess it is, organizationally speaking, within these large entities."
British policymakers, like their counterparts in the U.S., don't seem inclined to take the sort of steps that would make their jobs easier. Vickers's suggestion was the next-best thing.
"They feel the need to do something," Johnson said. "This is the least they could do."
Ultimately, the ringfencing idea is "terrific," Bhide said, "but no half-measures, please."
Shahien Nasiripour is a senior business reporter for The Huffington Post. You can send him an email; bookmark his page; subscribe to his RSS feed; follow him on Twitter; friend him on Facebook; become a fan; and/or get e-mail alerts when he reports the latest news. He can be reached at 1+917-267-2335.