Evercore Pan Asset

Sir John Vickers produced an elegant and sensible Interim Report into the banking industry. He concentrated on two main problems. How can a country the size of the UK play host to banks with balance sheets collectively several times the size of the UK’s National Income? And how can we have a competitive UK retail banking industry which provides good service and prices for individuals and smaller companies based at home?
 
His first task is to ask how do we handle future banking crises without stressing the UK taxpayers and public accounts too much. He points out that traditionally banks had been allowed to gear their capital around 20 times. In other words they could lose up to 5% of their assets before they were insolvent. In the giddy days of 2007-8 regulators allowed them to gear 50 times. A loss of just 2% of the assets put a bank at risk at those levels of gearing. The first conclusion is easy. In future no bank should be allowed to gear that much. We need to return to safer and more prudent times.
 
Sir John argues that there are two ways we could guarantee safety in future. One is to tell large global banks they need to have much higher capital. The requirement might be so high that no bank would want to stay in our jurisdiction, or it would struggle to offer competitively prices for services given the high capital costs. The other is to demand that UK banking is handled through entirely separate companies, so they are affordable to the taxpayer if they get into trouble. The rest of the former global banks would have to take their luck in the global market, without recourse to UK taxpayer bail-out.
 
He concludes that a sensible compromise would take features from both these solutions. Global banks would have to meet the higher capital requirements now being laid down in Basel III global agreements. The UK banking arm would need to be in a separate subsidiary, with its own ring fenced capital requirement to satisfy UK regulators. I suspect this will carry the day to the final report and legislation.
 
He also discovers that UK banking is not very competitive. The Big Four UK banks have a high market share in most banking activities, especially in banking small and medium sized enterprises. He identifies the 30% market share held by Lloyds/HBOS. He considers it is too late to demand disposal of HBOS, as the integration of the two banks has proceeded a long way. Instead he recommends requiring a higher level of disposals of assets by Lloyds in UK banking than the EU has demanded. Alternatively he thinks there should be a full Competition Inquiry into UK retail banking. He also proposes ways of increasing the ability of individuals and companies to switch banks.
 
The UK needs more bank competition, and more bank capacity. The Banking Commission have correctly identified the need to find new ways to protect the UK from a further banking collapse. They propose that in future the authorities should be able to pursue resolution, private sector solutions to overstretched banks, in preference to reaching for the taxpayer cheque book. They envisage a world where bank bondholders take a much bigger part of the hit from failure, with bonds converting into share capital to pay losses. They suggest that ordinary depositors should rank above other creditors. It must make sense to shift the burden of sorting out any new mess onto bondholders, shareholders and creditors, away from taxpayers. The UK was lucky that its over mighty and over large banks did not this time round bankrupt the country. Iceland and Ireland shows what can happen when a country’s banks are too large to bail and too large to fail.

 As published in Investment Week