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The Vickers legacy

20 March 2013

In this morning’s Financial Times, Martin Wolf (“Big trouble from a small country”) paints a chilling picture of banking and justly calls for a huge increase in equity capital. He starts from the Vickers Commission’s premise that the taxpayer must not be allowed to support the business of banking which is unavoidably risky, and infers that, in the absence of an adequate equity cushion, it is not unjust for larger depositors to be bailed-in to cover any losses.

Am I alone in regarding this as a rather curious suggestion? The depositors in a major British bank are a pretty diverse bunch of people. If you stop the music at any point, you will find a great many retired individuals, small businesses and people selling homes caught with balances over the compensation scheme limit: are they (who have no effective choice where they deposit money) really more responsible than the taxpayer at large for the mess we have allowed the banks to get into?

Wolf argues that protecting depositors “validates the riskiest business models”. In this he surely goes too far. Wiping out equity and bonds and sacking management has the same moral hazard deterrent as raiding the deposit base; moreover appropriating a random group of deposits has no different effect on bankers’ willingness to gamble than a taxpayer bailout.

The truth is that Vickers (by failing to challenge the remit the Government imposed on them, and ignoring my evidence in 2010 and 2011) failed to examine the root cause of the problems of banking, namely the industry’s inability to generate sufficient profits to pay bonuses out of socially useful activities. As is increasingly evident, their business model depends upon exploiting a seriously mispriced component in the transactions in which they engage.

This may be the implicit state support Vickers sought to free them from. Now instead the Government (in clause 9 of the Banking Reform bill) looks set to focus the unremunerated risk on uninsured depositors.

If banks cannot pay the proper price for bail-in bonds they must not be allowed to market large deposits paying interest rates at the same level as smaller guaranteed deposits. Not honouring depositors’ legitimate expectation of priority (in relation to existing term deposits or those taken out on the basis of continued misrepresentation) is state-assisted fraud.

The fundamental problems of banking were in no way addressed by ring-fencing – although the massive amount of debate that generated may be a measure of how difficult it would have been for Vickers to have taken a more radical approach. Total separation of the constituent parts of banking – in particular of the voting equity capital supporting the disparate activities – could well have been a useful step on the path: it would have permitted the market to tell the Government that non-state-supported casino businesses could not survive, and allowed them to wither without affecting taxpayer or depositor.

Vickers missed the point. Worse, it distracted attention from the issue at a time when there was a will to take the firm measures required. It may have been our last chance before the next crash.

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