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I WAS sad enough this morning to read the "Executive Summary" of the Vickers report on banking reform, published today. I know a little bit about this subject having worked in the City for a while.

The guts is that the government (with wide support in Parliament) intends to "Ring Fence", or partially separate, the retail banking from the merchant banking operations. This is supposed to be a safer arrangement, although the banks hate it because they'll make less profit.

But the ring fenced operations will share the same senior management and the same shareholders (!). There is not going to be a full separation. Sir John Vickers and his committee seem to beleive that the banks will implement these concepts faithfully, if unwilllingly. However, surely everything suggests that the banks will do everything possible to get around this legislation.

Maybe I'm missing something, but it seems that there may be one way to circumvent the intention of the new reforms.

If by collusion, MegaBank (Retail) and Megabank (Casino-division) get together, what will there be to prevent monies flowing from the former to the latter by means of external company X ? .


i.e. Megabank (Retail) lends money to X Plc and then X Plc lends money on to Megabank (Casino-division)? It is clumsy and could involve companies Y and Z, but it is surely a circumvention?






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Tags: banking, banks, casino, merchant, reform, retail

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Comment by Adrian Essex on September 16, 2011 at 12:00

a) are they cowboys or barrow boys? Willing to take a punt on iffy goods, in this case the Swiss Franc just before the Swiss government started selling them

b) depends if its before or after the fence around depositors' funds has been put in place - if before then quite probably yes, if after then no - let the casino go broke

Comment by Clive Carter on September 16, 2011 at 11:28

I noticed that a rogue trader at the Swiss bank UBS has managed to lose about US $2,000,000,000 yesterday playing the markets. He was in the alpha male-sounding "Delta One" team.

I wonder (a) how many cowboys are still in the casinos of British banks and (b) if taxpayers will have to have to step in to bail out the next British Bank that has losses of this order (Barings was let to fail after another Rogue Trader's actions).

Comment by Clive Carter on September 14, 2011 at 16:31

Conceptually, it seems that there are two kinds of situation where Megabank might want to gain access to cheap funds in their retail arm:


(a)  in a dire emergency, when Megabank (casino division) is facing a short-term liquidity crisis in order to provide a brief respite;

(b)  at all other times, when the large amounts of capital are available at low cost (i.e. a low cost of capital compared with alternatives), in order to boost ordinary profits of the casino division.


The temptation to access these monies, which the parent company controls, must be strong indeed. Both the retail & merchant banking operations will share the same senior management and the same shareholders: their interests remain aligned.


I too was surprised to read of the number of loopholes, one of which you highlighted Adrian. The fact its all going to be delayed for years is a cop out. I think between the draft and the final report, a big lobbying effort was made by the banks to water it down.

The dilemma for the government is that it is vital that steps are taken which will have the unavoidable effect of reducing bank profitability; on the other hand, it is vital that for the government that the banks are as profitable as possible in order that they can can rid of this unwanted and unloved asset as soon as possible and bring some money back to the Treasury.

What a mess.


Comment by Adrian Essex on September 14, 2011 at 11:04

I think the routing may be a red herring. I bleieve what the ring fencing means might be as in this example.

Assume Megabank has a total business worth £10bn of which retail banking is worth £1bn (however those numbers are calculated). If the capital adequacy requirement is set at 10% then overall Megabank must have £1bn of ready cash to cover eventualities, of which £0.1bn must be set aside (ring fenced) for retail. So if the 'casino' arm gets into trouble and uses up its £0.9bn dealing with (or failing to deal with!) whatever eventuality, the retail reserves will still be intact and the retail arm will remain viable. I think the company structure must also be such that the 'casino' can go broke, while the retail remains a going concern.

While the reserves remain intact the two parts of the organisation can cross-invest provided " relationships with other parts of the group should be no greater than regulators generally allow with third parties, and should be conducted on an arm’s length basis".

I read this as a hideous fudge - a governement which has promised to eliminate red tape is trying to protect retail banking with a set of arrangements which comprise entirely of red tape! As you say, the casino's implementation of this will be much cleverer than the legislators' drafting. A few people will make a lot of money out of the consultancy, retail customers will pay the price in monthly fees for bank accounts, and the net effect on the safety of the retail banking business will be sweet Fanny Adams. 

Comment by Clive Carter on September 13, 2011 at 22:54
Adrian: do you think that the banks could get around the ring fence "separation", by routing funds through a third party? Is this too obvious? Am I missing something?
Comment by Adrian Essex on September 13, 2011 at 21:48

I was working for S G Warburg in 1986 when, under the Big Bang deregulation inspired by Maggie Thatcher, SGW acquired Ackroyd and Smithers, Rowe & Pitman and the government gilt broker Mullens & Co.

Ackroyd and Smithers were jobbers, a company that was allowed to take positions on its own account, i.e. it could make a profit by trading in stocks and shares. Rowe & Pitman were brokers, who did not take positions on their own account but could buy and sell for clients  - the clients might make a profit or a loss but R & P would only take a commission. Mullens would get a commission from the government for selling Gilts. Up until 1986 SGW had been a merchant bank, taking some deposits from customers, offering advice on mergers and acquisitions, and generally having good ideas like the invention of Eurobonds.

After big bang, the investment bank was able to take deposits, take trading positions on its own account, offer advice to clients, take commissions for deals transacted on behalf of clients, offer advice on mergers and acquisitions, and manage funds on behalf of pension funds, and generally have bad ideas like buying huge quantities of toxic debt bundled up by cunning blighters overseas and misrepresented by ratings agencies as per Clive's earlier comments.

It is this combination of activity that George Osborne refers to as "casino banking" and wants to separate from boring , safe reliable licensed deposit taking, which is mainly what we the public need to pay our salaries into. Sort of undoing Big Bang?

Maybe we should have studied our history and had a little look at the Glass-Steagall Act. This act of 1933 separated investment and commercial banking activities. At the time, "improper banking activity", or what was considered overzealous commercial bank involvement in stock market investment, was deemed the main culprit of the 1929 financial crash. According to that reasoning, commercial banks took on too much risk with depositors' money. 


Comment by Adrian Essex on September 13, 2011 at 20:40

I don't know where to start in responding to these proposals and Clive's comments - I might have to go in very small steps so that I don't trip over my own astonishment. 

First the good news.

I might dust off my cv and see if I can't get a job working on some of the projects that will be needed to implement this. I was a business analyst - I am retired now - but I can still write well structured documents full of banking terminology, cost estimates, risk analyses and project dependencies, using proper grammar and illustrated with subtle powerpoint diagrams, at the drop of a hat. I was there in 1986 when investment banks were invented. I've worked on legislative changes such as Capital Adequacy and  Know Your Client. I've installed general ledgers which can attribute costs and income across company structures any way you want. I'm made for this project. And I'd expect to earn in excess of £1/minute for my services. That's where a large part of the £4 - 10 billion this change is estimated to cost, will go, on projects to define what needs to be done, and then on other projects doing it. Even companies which look at the requirements and then think 'No bugger this let's move to Dublin' will still have done the definition project.

So these proposals are very good news for hundreds, maybe thousands of project staff with the 'banking' on their cvs. 

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