The wrong ring fence

The chancellor of the exchequer, George Osborne, announced today that he intends to implement the main recommendations of the Vickers report; in particular, that banks should 'ring fence' retail banking operations from investment banking, which is perceived to be riskier. This is justified in the Vickers report by the claim that:

it would insulate vital banking services on which households and small and medium-sized enterprises (SMEs) depend from problems elsewhere in the (global) financial system.

Of course, that would be laudable. We wouldn't want nefarious casino bankers frittering away the savings of thrifty British workers by placing losing bets on complex derivative functions of various obscure foreign assets; thus unable to provide mortgages to “hard-working families” (I apologise for reminding readers of one of Osborne's illustrious predecessors) or working capital to hard-pressed small businesses. There is only one flaw in this argument: the banks that went belly-up in the UK in 2008—Northern Rock, Bradford & Bingley, Alliance & Leicester, HBOS, Lloyds, RBS—were exclusively or primarily retail banks; who were brought down by betting that they'd make a return on 125% self-certified mortgages (and the like) to Joe and Jane Public. So this particular ring fence would protect the bonuses of City wide-boys and fat cats from the delusions of overly-optimistic twenty-something house-buyers and whoever runs the computers that lend to them.

The terrifying thing about the 2008 crisis was the imminent threat that banks would conserve cash by halting payments to other banks representing normal commercial transactions, such as salary and trade payments; at which point everyone would be unemployed in short order. It is around the safe custody of money, and the transmission of money between safe-custody accounts, that a ring fence must be built. This is a low-risk, well-understood business with predictable costs.

On the other hand (or the other side of the fence), buying and holding financial assets, whether Joe Public's mortgage or Greek bonds or some derivative thereof, is inherently risky, especially under the fractional reserve system where my bank deposit might be used several times over to back such purchases. I'm very uneasy that money intended to pay housekeeping or wages or otherwise lubricate the wheels of commerce is used in these ways, without any explicit choice by the depositor. If I have spare money, which I want to bet on a risky venture, well and good, but it should be explicit, with my eyes open.

Of course, to erect such a fence, a very British sacred cow, standing in the way, will need to be slaughtered: the idea that banking should be free. If you want your money genuinely looked after (in a secure computer, in a vault), and not used as a poker chip by an anonymous gambler, I'm afraid it costs. So does moving it securely between vaults. And converting it to paper spewed out of a wall. I should know, because it's my business.

One other thing about Osborne's proposals: he wants them implemented by 2019. As Margaret Thatcher used to say to civil servants, World War Two was nearly lost and then won in less time. The nuclear bomb of Club Med default is almost certain to go off a lot sooner.