Banks' retail and investment banking activities should be separated, but not into different institutions - this was the main point of a long-awaited interim report on ways to safeguard the future stability of Britain's banking sector. The report was issued in April by the Independent Commission on Banking, a body set up by the government in June last year to consider this topic, and has been dubbed the "Vickers report" after the ICB's chair Sir John Vickers, a former Bank of England economist and a distinguished academic. The ICB stated that the Vickers report represented its "provisional views on the need for reform and on possible reform options".
Before the Vickers report was issued, the biggest question for those waiting for it was whether the ICB would advise the breaking up of universal banks - that is, those such as Barclays or HSBC which undertake both investment banking and retail banking activities. It's generally accepted that greater protection of deposits is needed to avoid a repeat of the scares of autumn 2008, when retail customers faced the prospect of their savings being wiped out thanks to their banks' imprudent activities. But the less draconian option of constructing "firewalls", legal divisions between different sectors of universal banks' businesses, was also understood to be under consideration.
In the report, the ICB stated that it currently sees firewalls as the best option as separating banks more formally would mean that some of the benefits of universal banking would be lost, customers would suffer during the upheaval and the administrative costs to the British economy as a whole would be high.
Another recommendation made in the interests of banking stability was that banks should generally be required to hold capital reserves representing 10 per cent of their investments in risk-bearing assets to ensure that they are able to meet their obligations at any given time. Holding capital reserves is expensive for a bank as the ways in which these funds can be invested is very limited or non-existent, and so historically banks have resisted increases to capital reserve requirements. However, in the light of the financial crisis, it has been accepted that higher capital reserves are necessary. There have also been international moves along these lines. The Basel Committee on Banking Supervision, the multinational body which makes best practice recommendations on this issue, has stated that all banks should be required to hold the equivalent of 7 per cent of funds invested in risk-bearing assets in reserves. The ICB also suggested that banks' retail customers should be given priority over corporate creditors in the event of a bank's insolvency.
Facing the competition
One notable omission from the report's comments on stability was any comment on how staff at banks are paid - it's been suggested that the high bonuses available to bankers played a role in promoting excessive risk-taking before the financial crisis. This omission has not gone unnoticed - members of the House of Commons Treasury committee asked Sir John to ensure that the final report considers bonuses.
The ICB was also asked to consider ways in which the UK's banking sector could be made more competitive. The report referred to steps already underway to reduce Lloyds' current share of roughly 30 per cent of the retail banking market, which it acquired thanks to its 2008 rescue of the then-ailing HBOS. It also suggested that measures should be taken to make it easier for customers to change current accounts. Finally, the report proposed that the Financial Conduct Authority, the arm of the remodelled FSA responsible for policing how businesses in the UK's financial services sector deal with their customers, should have a duty to promote competition.
The report also tried to allay fears that increased regulation of the sector could hamper the UK's economic position worldwide. The report pointed out that increased financial stability should make the UK a more attractive place to do business, and that in reconsidering the checks and balances on its banks, the UK was in line with an international impetus towards reform.
The ICB asked for responses to these provisional views for it to consider before producing its final report, which is due in September.