Vickers: UK reform on track but Europe questions remain open

Speaking on Tuesday at a lecture series hosted by Pinsent Masons, the law firm behind Out-law.com, Sir John, who chaired the Independent Commission on Banking (ICB), welcomed progress towards banking reform in the UK while highlighting unresolved questions in Europe.

The Banking Reform Bill, which had its second reading in the House of Commons this week, will deliver the bulk of the ICB's recommendations if it is enacted in its current form. The Government has already announced its intention to amend the Bill to give regulators the power to separate the activities of individual banks that do not comply with the new requirements following pre-legislative scrutiny by the PCBS.

On “ring-fencing” retail from investment banking he said: "I welcome anything that makes the ring-fence stronger and more durable, including ‘electrification’ – the idea of the PCBS”. The ‘first reserve power’ recommended by the PCBS would enable total separation of individual institutions that sought to undermine the fence.

“I would however pause before putting in this Bill the 'second reserve power', to have a sectoral split," said Sir John. "We did not recommend a sectoral full-break up because we believe ring-fencing will work, and because if you had a sectoral split then you would be creating a standalone UK retail banking sector which might be very highly correlated within itself."

"This would mean that, in the event of a UK rather than global financial crisis, you could not have the rest of the bank rescue the UK retail banking sector," said Sir John. "If I was proved wrong, and a sectoral split did prove necessary, my constitutional feeling would be that that should require fresh legislation. On that, I am not against the Government view on the current Bill”.

Vickers' Independent Commission on Banking (ICB), which delivered its final recommendations to the Government in 2011, believed that 'ring fencing' banks' retail operations into a separate subsidiary of a wider banking group would be "better for financial stability" than full separation from their investment activities, he said.

Once approved, the ring-fence will ensure that retail banking activities are provided by a separate subsidiary of a wider banking group. Ring-fenced banks will need to be legally and operationally distinct entities from non ring-fenced banks, and will not be able to own or hold the capital of other non ring-fenced entities within the group.

Only ring-fenced banks will be able to accept deposits from, and provide overdrafts to, retail customers. They will not be able to carry out certain pre-defined activities including international and wholesale and investment banking services, and dealing in investments as principal. However, they may be permitted to provide "simple" derivative products to their customers provided that a number of conditions are met. Once the Bill is approved, it is anticipated that banks will have until 2019 to comply with the ring-fencing requirement.

In his lecture, Sir John said that the Government's response to the recommendations of the ICB and the PCBS had been "very positive", although it had not wholly implemented either body's proposals for reform. Some of these changes, such as the inclusion of a 'de minimis' exemption from the ring fencing requirements for smaller banks, had been for the better, Vickers said. However, he said that the Government had been "unambitious" by proposing that banks need only meet international leverage standards, rather than the stricter cap proposed by the ICB.

The leverage ratio refers to the total amount of capital held by a bank as a percentage of its assets without weighting for risk. Basel III will require a maximum 33x leverage ratio, and so the ICB recommended a "completely logical" 25x leverage ratio cap "in step" with the higher capital requirements for large UK retail banks recommended by the ICB. Both the ICB and the PCBS have argued that the UK's high leverage ratio in the lead up to the 2008 financial crisis played a significant role.

"You had this crisis where excessive leverage was a fundamental precondition to why things went wrong," Sir John said. "The international community is yet to agree the 33x cap, but I think it is unambitious and they ought to do more to reflect the imperfection of risk weighting."

Sir John said that European proposals for structural reform were a "very important space to watch". Recommendations made towards the end of 2012 by Bank of Finland Governor Erkki Liikanen were "remarkably in harmony" with the ICB's proposals, but whether the European Commission would ultimately adopt them "remained unclear".