Defined Terms and Documents
Ring around the roses
OPINIONPosted
It is reputed, and also disputed, that the nursery rhyme Ring Around The Rosy refers to the habit of clutching a posy of flowers to one's nose to ward off the Black Death.
The 21st-century equivalent is to put a 'ring fence' around an equally deadly pestilence, investment banking. In the UK overnight, the Independent Commission on Banking (ICB), which was set up in the wake of the global financial crisis (GFC), issued its final report basically saying - out damn spots.
The ICB's report is huge, some 363 pages of what in essence is an argument to trim the sails of investment bankers, by separating retail deposits from the casinos of Wall Street and Canary Wharf. The report does not go quite as far as splitting off the investment banks altogether as recommended by the ex-chairman of the Federal Reserve, Paul Volcker, but does suggest 'ring fencing' the retail operations. The ICB proposal is not for a divorce but a separation with, as the report says, retail subsidiaries being "legally, economically and operationally separate from the rest of the banking groups to which they belonged". Only the emotional attachment appears to survive?
Expect bankers to squeal long and loudly, London Bridge really is really falling down. Expect too the name of the hated chairman of the commission, Sir John Vickers, to become instant cockney rhyming slang, it rhymes with lady's undergarments after all. But, for some inexplicable reason, Vickers and co have left implementation of the 'firewall' to 2019, so there is still plenty of time for large banks to mount a mining-like campaign against the proposals and to get them watered down.
But what does this all mean for the Land Down Under?
At first, of course, there will be the inevitable self-satisfied "couldn't ever happen here" response of the financial commentariat and local bankers. But then there will be time for proper reflection.
The four pillars of Australian banking are all, what Vickers calls, 'universal banks' with multiple financial services under one corporate umbrella. Not only are the top four retail banks in single structures but also four of the top five superannuation companies in the same corporations, and so too some of the biggest insurers. The big four banks have you covered from cradle to grave.
The traditional arguments for having all financial services under one umbrella are efficiency (bigger is better) and customer service (we have all your details so we can sell you more stuff you don't really need). Undoubtedly, having access to relatively cheap depositor funds makes making money on the investment banking side easier. But is that efficiency, or just free riding?
Vickers skewers the efficiency argument, noting that bigger banks take bigger risks and, because they cannot be allowed to fail, need more taxpayer support when things go wrong. He dismisses the argument that not all banks that failed in the GFC were large universal banks, for example Lehman was essentially an investment bank (but did have retail banking operations in the US). But in the UK all the large banks needed taxpayer or sovereign wealth fund support during the crisis, because they had overstretched.
Once the blizzard of babble from bankers in denial is over, it will be time coolly and calmly to look at the question from an Australian perspective. Just what benefit does it give to taxpayers and pensioners to have their banking and superannuation savings under one roof with investment banking? The latest APRA quarterly superannuation report, released just last week, tells the same depressing story it almost always does – retail funds (i.e. the big banks) underperform all other types of fund. So exactly where is the efficiency?
The four pillars policy has served Australia well in the GFC, since it relies on the diversification of management talent rather than credit diversification, assuming that not everyone can be an idiot at the same time. Or can they, is there an Australian housing bubble or not?
But the four pillars policy does not necessarily mean that the four big'uns should just get bigger, unless there is a good economic reason for doing so (economic that is to the taxpayer not the bankers themselves).
Already bankers in the US are complaining and threatening divorce over the new Basel III capital rules (adopted slavishly by APRA) and expect even more weeping and wailing when the impact of Vickers is understood. Is it not about time that the Productivity Commission took a look at Australian banking and asked the question – what banking system would suit Australia best for the 21st century?
Dr Patrick McConnell is a Visiting Fellow at Macquarie University Applied Finance Centre, Sydney, where he teaches postgraduate courses in risk management, with an emphasis on banking regulation.