|Photo courtesy of www.guardian.co.uk and Andy Rain/EPA|
Today at JP Morgan, George Osborne announced that 2013 would be “the year we re-set our banking system”. He is forcing big banks to ring-fence their riskier investment banking operations from their retail operations, threatening that those banks which fail to comply will be separated completely.
But what does ‘ring-fencing’ mean? At the moment the investment banking division of big banks uses money from their high street operations (i.e. the money that we put into our current accounts) to fund their riskier investments. This is what happened during the financial crisis of 2007, which meant that the government was forced to bail out banks with tens of billions of the tax payers’ money, otherwise the money which people had saved in high street banks would have been lost. In the new system, investment divisions will have to have enough money in their own accounts to fund riskier investment strategies, therefore they will put the taxpayer and the economy in a much less dangerous position.
As George Osborne said “Irresponsible behaviour was rewarded, failure was bailed out, and the innocent - people who have nothing whatsoever to do with the banks – suffered.” Under the new system there will be “no more rewards for failure. No more too big to fail. No more taxpayers forking out for the mistakes of others” he said.
But it is not only the accounts which will be separated, Osborne has called for separate people to oversee the investment operations and retail operations, rather than one CEO for the whole bank, as we have at the moment.
Following the LIBOR scandal (see my earlier article) the government set up the Parliamentary Commission on Banking Standards, which suggested that in order to avoid a repetition of the financial crisis, the government should have the power to break banks up if they did not put the ring-fencing reforms into action.
However the British Bankers’ Association is not happy with the reform. They have said that it will create uncertainty and will mean that bankers will find it harder to raise capital, therefore they will not have as much money to lend to small businesses, which will damage the economy. In addition, the projected costs of putting the reform into place are very high – these costs will undoubtedly be passed onto consumers in form of higher costs of high street banking, in particular higher costs of lending. However scandal after scandal has led to the public’s lack of faith in the banking sector, therefore the public are unlikely to sympathise with the worries of the British Bankers’ Association.
Hopefully banks will comply with the new reforms, otherwise Osborne will electrify the ring-fence with legalisation and separate big banks completely.