The Radical Shakeup

Here is a brief overview of one set of potential regulatory reforms that has been proposed to parliament. Sir John Vickers and his commission prescribed these changes in a report almost two years ago, and a recent  press release from the Chancellor of the Exchequer offers a glimmer of hope that they may yet me implemented.George Osborne's Speech in Full

The Three Key Goals-

(i)                 Ring Fencing

At the centre of George Osborne’s speech two weeks ago in which he promised an end to light-touch regulation, was the need for widespread ring-fencing in the financial sector. The idea is to separate critical banking-services whose disruption would have a substantial negative impact on households and SMEs, from those deemed superfluous. In doing this the aim is to insulate services essential for a well-functioning economy from negative shocks to other parts of the financial system, thereby preserving the advantages modern banking provides. Simultaneously, the ‘unspoken promise’ that the government will be obligated to step in and bail out floundering banks will be markedly reduced, perhaps then the Lender of Last Resort facility would  more closely resemble that which was originally described by Bagehot. (A fellow classmate of mine discusses LOLR in more detail - (http://evolutionoflolr.blogspot.co.uk/2013/02/lolr-and-financial-crisis-is-it-used-as.html )

(ii)               Loss- Absorbency

Since I have stressed the nature of cyclical losses in the banking sector as being preordained, absorbing these periods of poor growth is critical. Loss-absorbency is not directly a structural modification but is equally as essential. A new leverage-ratio, bail-in process and depositor preference are the tools charged with improving the UK’s ‘primary loss-absorbing capacity (PLAC)’ (HM Treasury, 2012) and ensuring banks are sufficiently capitalised to survive adverse shocks. In effect this is an extension of the capital requirements made under Basel III

Here is what the new PLAC reforms look like:

Source: www.hm-treasury.gov.uk – White Paper Reform

        

(iii)         Increased Competition

The final piece to the jigsaw is the fostering of an environment of healthy competition. Only in a setting of actual competition can the prices of products and services be efficient and the innovation required for sustained growth be cultivated. Through activities such as the divestment of part of Lloyds Banking Group (YahooFinance, 2012) and the acquisition of Northern Rock by Virgin Money (The Guardian Online, 2011) the Government is clearly active in its pursuit of this objective. However, reduction in barriers to entry and pursuit of a more transparent retail banking sector still appears a long way off.

What is needed, and what this framework seems to be aiming for, is a simpler structure. Similar to the way the financial industry looked before the 1970s & 80s, we need to break up the system into components which are both simpler to operate and understand as well as being independent from one another. The result will be an environment whereby individual firms can be allowed to fail without resulting in a great deal of damage to the system as a whole. Furthermore their failure will not result in to quite disconnected parts of the market becoming victims of contagion.

Full report can be viewed at – http://www.hmtreasury.gov.uk/d/whitepaper_banking_reform_140512.pdf