I thought I had informed myself fairly well about the background to the financial collapse. However, I recently listened to a superb address by Michael Portillo when he indicated that the gross value of outstanding credit default swaps is roughly equivalent to five times the global GDP! If they all netted back to zero that would presumably not be a problem but if not .........! Recognising the risk, he also expressed the view that many of these transactions should not have been allowed in the first place because of their potentially toxic effect and indicated that there should have been far tighter regulatory control. This lead me to consider the implications of the Independent Commission and Banking (ICB) report. While I cannot claim to have absorbed the whole of the report in detail there were some astonishing conclusions in the executive summary and I quote:-
- The best policy approach is to require retail ring-fencing of UK banks, not total separation. The objective of such a ring fence would be to isolate those banking activities where continuous provision of service is vital to the economy and to a bank’s customers;
- This would require bank’s UK retail activities to be carried out in separate subsidiaries. The UK retail subsidiaries would be legally, economically and operationally separate from the rest of the banking groups to which they belonged. They would have distinct governance arrangements, and should have different cultures;
- The aim of isolating banking services whose continuous provisions is imperative and for which customers have no ready alternative implies that the taking of deposits from, and provision of overdrafts to, ordinary individuals and small and medium-sized enterprises (SMEs) should be require to be within the ring-fence;
- Subject to limits on wholesale funding of retail operations, other banking services – including taking deposits from customers other than individuals and SMEs and lending to large companies outside the financial sector – should be permitted (but not required) within the ring-fence;
- The Commission’s view, in sum, is that domestic retail banking services should be inside the ring-fence, global wholesale/investment banking should be outside, and the provision of straightforward banking services to large domestic non-financial companies can be in or out; and
- The aggregate balance sheet of UK banks is currently over £6 trillion – more than four times annual GDP. On the criteria above, between one sixth and one third of this would be within the retail ring-fence.
From this I deduce that only about 16% of the overall banking industry is required to service the need of individuals and SMEs about 64% sits outside the ring-fence and is presumably not “vital to the economy” with the remaining 16% sitting in or outside the ring-fence on a discretionary basis.
An article in last week’s Economist suggested that some of the banks may again need to be re-financed to meet more stringent new EU capital requirements and it was suggested that as much as £25Billion might be required to re-capitalise RBS. Those of my friends and contacts who still go to work in the banking industry must despair of the fact that they are trying to run decent businesses and drowning in toxic waste from above.
The sums of money which have been required to stabilise the banking system are so colossal that it makes one wonder whether the SME community might be better served by setting aside a small proportion of that capital as the core capital for a new bank dedicated to serving the needs of the country’s SMEs. These are the companies upon which the country is absolutely dependent for growth. If we are to rely on them to provide that growth, it is essential that we find a better way of “putting fuel in the tank”.