Sir John Vickers Report - An Analysis on Ring Fencing the UK

Yesterday marked the release of the anxiously awaited Sir John Vickers' government backed Independent Commission on Banking report. The headline statement called to implement regulations across Britian's major banks referred to as 'ring fencing,' a paradigm which would separate Investment Banking division from Retail Banking. In theory, this division would remove the need for tax payers to foot the bill for British banks in the event of another credit crunch in the future, while in practice the outcome may be fickle at best. Before examining this in detail, I first think's important to examine two representations from well informed sources which caught my eye.

For privacy reasons, I shall omit the name of the first speculator and refer to him as a top analyst employed at Investec in London who follows the financial sector. When I asked his view on ring fencing, his response followed; "ring fencing is a solution in search of a problem. Ring fencing wouldn't have prevented the fall of Northern Rock, Lehman brothers or exempted the need for the government to bailout RBS or HBOS." He developed to state "what happened in 2008 was natural selection; those who were weak got taken out and now, 3 years down the line, we're going to over regulate those who were strong enough to survive in a period of futile recovery." I must say, at the time I shared his view. The ICB would call to close the door after the horse had bolted.

A paragraph in the 'Comment' section of Tuesday's Evening Standard offered up an opposing view from another city insider (again, anonymous): "A glance at the banks' record over the past 30 years shows how parasitic the current arrangements are. He says that over that time frame bank shareholders have lost much of their money, retail savers have done very badly, taxpayers have thrown in billions to keep the banks afloat, and the people who work in financial services have made a bomb." Another hard hitting statement.

Having watched the Q&A session with Vickers yesterday morning it occurred to me despite the disastrous impact this will have on Britain's banks, this is the right action. The ICB is not calling so much for banks to implement ring fencing, it is calling for the government to ring fence the banks from the tax payer.

Having said this, the report painted a disastrously bleak tone for the future of UK banks and indeed therefore the future of the UK's economy. First lets take a look at the indicative headline figures:

• Cost per year: £4-7bn - to be absorbed by banks' shareholders, employees and balance sheets 
• Equity capital increase to 10% of assets (Basel III: 7%) 
• Banks should have loss absorbing capital of between 17%-20% 
• Due date: 2019 

In their rawest form, the numbers spell an end to an era of extreme leverage within the UK. Where as before banks could use money deposited by individuals for their speculative, investment based activities, post 2019, they may only use capital proprietary to their investment banking divisions. This means risk will be reduced on the front of the consumer (those with money held in retail bank accounts), but also on the part of the investment bank. If you subscribe to an efficient market hypothesis theory (which regrettably, I do) you'll agree that lower risk will result in lower reward which shall effectively equate to the end of the colossal profits witnessed by Britain's banks up until now. Unfortunately for the rest of us, this shall also have an impact on our economy as financial services are estimated to make up 10% of our annual output with some citing this change to result in a 0.3% decline in economic growth.

Therefore, I take a negative outlook in terms of the future of this country. Although in this instance I believe the benefit of this regulation marginally outweighs the cost, I do not see where growth will come from in the near future. Our service sector is suggested to account for 77% of our economy and by imposing tighter regulations we render ourselves less competitive with other more cavalier nations throughout the world. I do not think the banks will relocate their London HQs but I do think the government needs to keep a close watch on the resultant outcome and review regularly whether the benefits to the people of Britain are being outweighed by the possible slump in our future performance as a nation.