Crisis in International Banking. ICB Report Calls for Reform

Back in April this year the UK Independent Commission on Banking (ICB) published its Interim Report on banking reforms.  In the wake of the global financial crisis this report investigates some possible ways to improve stability and increase competition in the UK banking sector.  

This is a 214-page document which explores the options for banking reform and presents the provisional opinions of the commissioners in considerable detail. But don’t worry: we have read it so you don’t have to!  In the interests of making sure we are completely up-to-date with the very latest developments in the world of international banking we have spent many hours reading, studying, assimilating and digesting the report. 

Now we present the main features and highlights, and consider what impact, if any, it will have on you and all our valued customers and their computer systems in the coming months and years.

The Commission’s final report is due to be published this September.

Readers of the Interim Report are invited to contribute to the debate by responding with their own views and analysis.

What is the ICB?

The ICB was created in June 2010.  It was announced by the UK’s Chancellor of the Exchequer but is independent from the British Government. Chaired by Sir John Vickers, former Chief Economist at the Bank of England, its other members are Clare Spottiswoode, Martin Taylor, Bill Winters and Martin Wolf.

The financial crisis, triggered by excessive and ill-understood risks taken on by both lenders and borrowers, began in 2007 and is still unraveling today.    The consequences have been severe, world-wide and long-lasting, and have impacted everyone from whole countries and their governments, international corporations and businesses, right down to families and individuals.

The catastrophic effects have included the collapse of financial institutions, the bail out of banks by governments, and a downturn in stock markets all over the world.  At the human level it has brought unemployment and insecurity; many have lost their homes as well as their livelihood.

The crisis has exposed fundamental weaknesses in the global financial system; in its wake governments are considering banking reforms to promote financial stability and competition between banking institutions.

Too Big to Fail, or Too Big to Save?

Such was their size and influence, back in 2007, the global megabanks were universally acknowledged to be ‘Too Big to Fail’.

Not only are individual banks massive institutions in their own right, they are so inter-connected with each other that if one of them should fail, they could all come tumbling down one after the other like a row of dominoes.

                       

The financial, social and political fall-out from the collapse of these huge international institutions was considered to be so enormous, and was so feared, that multi-billion dollar Banking Bailouts were ordered, in the US by President Obama & in the UK by Gordon Brown, all financed by taxpayers’ hard-earned money.

During the crisis Britain alone spent more than 65 billion pounds in taxpayer funds rescuing Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc. If further bailouts become necessary it is feared that the cost would be too great even for governments to bear, hence the banks would become ‘Too Big to Save’.

The ICB’s report is part of a drive to investigate and initiate the changes needed to protect the UK and its financial institutions against any possible future crises.  It recognizes that there are always likely to be unavoidable global financial shocks which all banks will have to contend with, but aims to find a way to ensure that they are in a better condition to cope with such crises when they occur.

What are the Options for Reform?

The recommendations can be boiled down into three fundamental measures:-

1.   Increase the liquid assets of the banks. With greater liquidity, when unavoidable international losses occur they will be better equipped to absorb them and carry on.  Banks will probably be required to hold more equity in relation to their assets and to ensure that where losses occur they are borne by their creditors rather than by the taxpayer.

2.   Reform the structure of the banks so when problems occur in the future it will be easier to sort them out. This will probably involve re-structuring the banks in order to distance retail banking from the riskier business of investment.

3.  Increase competition between banks, so there are more but smaller banking institutions.  This would provide greater choice for ordinary account holders and encourage banks to improve the quality of their services. Lloyds Bank was singled out for a recommendation that it should sell a number of its High Street branches. 

If it comes to the crunch, banks SHOULD be allowed to fail in the future, as long as customer bank accounts are ring-fenced to protect the ordinary consumer (safe failure, as Sir John Vickers calls it).

At the core of the commissioners’ recommendations lies the concept of ‘Ring-Fencing’.

In other words, the distancing and partial separation of retail banking from the investment arm of the business.  The commissioners stop short of calling for the separation of retail and investment into completely separate entities, but stress the need to protect the interests of ordinary bank account holders from risks arising elsewhere in the bank or in the wider banking system.

                       

How Will IT Systems Be Affected?

The ICB report acknowledges that payments systems sit at the very heart of the banking system and that they are vital to the UK economy as well as to individual customers and businesses:- 

‘Over time banks have developed complex networks that enable them safely and efficiently to transfer funds between different bank accounts…disruption of a payments system could de-stabilise the financial markets and cause wider economic disruption’      IBC  Interim Report, Section 2.6)       

This premise will have a bearing on any structural changes that are ultimately enforced as a result of the commissioners’ investigation and proposals.

One interesting suggestion for promoting competition between banks is for re-usable bank account numbers.  The idea is that customers should be able to transport their bank account number between banks as easily as they can move their mobile phone number to a new service provider.

Worldwide Fallout from the Crisis  

Separately from the ICB’s proposals, the European Commission on Banking is expected to make legislative proposals of its own, as part of upcoming amendments to the Capital Requirements Directive (CRD).

The ICB is not alone in championing the requirement for banks to maintain a larger buffer of financial assets; the Basel Committee has already announced its endorsement of the capital and liquidity reform package known as Basel III.  The full Basel III package is likely to be introduced in gradual instalments, to compensate for the current fragile state of the international financial recovery.  It is thought that it will be another 7-8 years before it is implemented in its entirety.

The ICB commissioners believe that the recommendation for increased liquidity and an equity ratio of at least 10% is an issue which should be agreed internationally.  If it turns out that this suggestion is not adopted internationally they would still insist on it being accepted by the banks in the UK.

In relation to the over all size of its economy the UK has a large banking and financial sector.  In the event of any future financial crisis it is therefore more at risk and has more to lose than most other countries.  These are important factors which will influence the British government when it comes to deciding how and when to proceed with the ICB’s final recommendations.

Another potential side-effect of the reforms is that European banks may be able to take advantage of the increased costs forced upon the UK banks to offer their customers more competitive rates, and grab a share of the lucrative British market.

What Happens Next?

For those wishing to learn more, the full text of the report can be viewed at

http://bankingcommission.independent.gov.uk/

 

For further information on this issue remember to keep an eye on the ProSwift website, The Banking Reform Bulletin Board and future editions of our Newsletter.  As always, if you need help and guidance in handling mandatory legislative changes to your payment systems, support is available from our expert consultants. For our regular customers and subscribers, the ProSwift Knowledge Bank is a useful resource for technical know-how and tips for handling VisionPlus system changes.

The commissioners are due to publish their Final Recommendations in September 2011; we will be watching carefully to see what they come up with and how it will impact on our clients.

Remember that the UK government is under no obligation to accept the Commission’s recommendations and may react with counter-suggestions of its own.  Watch this space!