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Narrow banking would not have prevented the financial crisis. Northern Rock and Bradford and Bingley were narrow banks - and the parts that brought down RBS and HBOS were the "narrow" bits, not the investment banks!

The problem is not even the size of the banks - though that does make a contribution. The real problem is something more subtle but, when you see it, much more obvious:

All these discussions about narrow banks, casino banks, investment banks are a pile of rubbish pelted by ignorant people.

Here are the two main issues:

1)A bank with poor risk management is a casino bank, nothing to do with investment, commercial or retail.
2)A society living on credit with huge amount of debt is a casino society

Deal with it!

As usual I find the UK political knockabout depressing. There is a major issue left unanswered in this discussion. All commentators appear to agree that bailing out of the ailing banks was the correct government decision. However, most believe that letting Lehman Brothers fold initiated the crash. So in the future do we really have any idea of what size of bank should be supported by governments and what financial structure would be required to do this. Surely, a concensus on this issue would limit the political options. As you have pointed out on several occasions, governments would either have to limit the size and structure of banks to be left to fail, or they would have to limit their operations to minimise the chances of failure.
It's the numbers that matter.

Narrow banking worked until the break up of the sensible deal in the 90's then a huge build up of risk occured. Coincidence? Don't tell me it didn't contribute. Break them up or we won't survive the next one.

Leigh: You make a good point in your blog. There are definitely patterns of behaviour here that are worth looking at. The fact that essentially the over-availability of mortgages was driving a boom in house prices. The fact that nobody seemed to want to perhaps stop that from happening.

The house price boom was great for everyone who could afford to get the house early on and then reap the profits of the added value. It was getting so silly that people were actually buying houses far outside of their ability to pay back the mortgage in the hope to cash in on price rises.

It doesn't take a genius to see that inevitably there has got to be a crash, the fact that the banks who were fuelling this sillyness eventually collapsed isn't that surprising either.

So the failure of government to act to slow this house price boom has got to factor into any reform plans. If regulation didn't work to actually control that kind of obvious boom, then how is it going to work to control a less obvious boom (say in some overseas development where the boom is far more opaque).

I'm not sure that "breaking up the banks" and "adding a tax on transactions" are opposed. Why wouldn't we do both?

What never seems to register with people is that more regulation only enhances the "game" that the "immensely bright" banking "innovators" get to play. This is why the intensely rules based system applied by the US is more likely to be abused (ala Lehmann) than the principles (sic) based one in the UK. The UK system should not allow the rules to be side stepped as the mere action of doing so is against FSA principles. Unfortunately the UK system was not properly policed, independent FSA inspectors should have been able to say "I don't like the look of your balance sheet, its too risky pay a (secret) 100K fine, and come back to me with a reduced risk plan in 28 days", the financial equivalent of the apochryphal clip around the ear. This would giive immense power to the FSA inspector but should help recruitment and keep down FSA salaries, massive power can make a job feel very attractive.

The other thing it might do is get risk departments looking at risk and not at whats the minimum we can do to comply with regulation.

Laws provide boundaries that create an illusion of safety when a rational viewpoint would often provide better protection for all concerned.

> The MPs are criticising the Treasury for failing to consider the option
> of breaking up the banks, into so-called "narrow" banks - that would look
> after our savings and be protected in an explicit way by the
> state - and more speculative banks that would not always need to be
> bailed out by taxpayers as and when they ran into dificulties.

You got it spot on except that speculative banks must never be
bailed out. This is very good news, and we are finally moving in
the right direction. Like I said at the start, we're starting to
break up those banks, making them safe and small. They must never
be able to threaten again.

The first thing about this is that, as much as the Government might try to hide behind a world recession, the demise of the banks is fair and square at the door of Gordon Brown for failing to regulate. And encouraging the spiv society that spawned Fred Flintstone and his ilk, and all the others who were asleep on the job. Like the Bank of England, the FSA, the Treasury, the MMC, and people like Vince Cable, who has been a star since the collapse but who was nowhere to be seen during the "good times" of boom. Gordon Brown's boom, based on six times earnings without much analysis on credit worthyness, unlimited credit on credit cards, buy now pay later, and all the other aspects of Gordon Brown's Spiv Britain. Want a house? Or ten houses? Just watch the ´óÏó´«Ã½ who will show you how to make a fortune out of buying a wreck, doing it up, and selling it on. At a profit.

As far as the plans for a bank tax, particularly on those banks largely owened by you and me, it is like taxing yourself. In any event, if they make profits again they will be paying loads of tax. Which will help the economy, always provided the profit is based on fair trading. What we need is the "bad" banks to be allowed to recover, as they surely will (at least Lloyds and RBS will) so that we can make of profit when we sell them. Us, the taxpayer. And while we are waiting for all our shares to be taken up by investors we need to have in place regulation to ensure it doesn't happen again. Not punitive measures but measures designed to revert our banks to prudence and providing a service for savings and loans.

The banking failure is Gordon Brown's and the solution to that failure is to boot him out. Unceremoniously. Time to call the removal men to Number Ten Downing Street.

If I look at Britain over the decades I cannot help feeling that somehow, one way or another, Governments contrived to "organize" one large Ponzi scheme after another.

There must be some underlying malaise, desease, if you like, for which there seems to be no cure on these shores. Should we start thinking in terms of a genetical defect? Or is it a matter for a psychologist?

We have been waiting for our fabulous leaders to do something proper and sensible in the direction of bank regulatory reform for quite a long time. So there's one rather depressing comment in the above report, namely:

"......the debate on banking reform should remain AS WIDE as possible.."

Wake me up when they've decided to narrow it please, by then we may just be getting closer to someone actually making a decision! (How much do we pay these people. They're not worth half!)

I'm happy to have profitable banks, just NOT one's that cause boom and bust (in the pusuit of profit,) and then need bailing out by the taxpayer every 10-15 years or so. If that means separating the casino's from their boring bits...so be it!

As said before its not the size of the bank that caused these problems, more the culture and the chase for giving out credit to many who could not afford it along with poor to incompetent risk management. A tax will not work, a big stick will not work, the better solution is to get rid of the ideas of just, for instance, sending out a form to whoever to ask if they want a credit card. Any psychologist worth his, or her salt would be happy to explain what happens next.

Te better solution, would be to train senior bankers in people skills, then 'invent' products that work in the long term.

wasn't too hopeful that a report entitled "Too Important to Fail - Too Important to Ignore" was going to be that objective.

I suspect breaking up banks would have little consequence as in reality bankers will still run with the hurd. I also suspect that unravelling banks and the legalities would take a minimum of decades. The Lehmans structure which allowed deals to take place in the UK which would not have been allowable in the US was a relatively simple structure by banking standards, who owns what would literally lead to total confusion in the banking world.

I also see the reward for the man whoes watch the crises started on, didn't see a thing comming despite his wonderful breakfasts with the heads of the banking world, who many blame for the crises being esculated, is to be rewarded for his snake in the grass attack by being capo di tutti capi of financial regulation and supervision.

Surely the option of having sufficient narrow banks for people to invest their savings if they so wish is a simpler explaination

The cornerstone of this report's findings is the admission that regulation has failed, will continue to fail in protecting against systemic risk hence the conclusion: cut banks down into narrower less dangerous organisations. One needs to consider whether this is the agenda of those in the regulator/governing class seeking to offload responsibility for failing to control massive leveraging, when they were aware of the exploding balance sheets.

That point aside, I agree with the thrust and the Volcker approach. John Varley made the point that some of Barclays' biggest customers for its investment bank are sovereign governments. Governments rely on these big market-makers to supply them with affordable credit for their own deficits. The concentration of power is made more threatening by their global reach. President Obama is alive to this and wants to kill it off.The corollary must be that governments should also put themselves in to sustainable fiscal balances and not themselves feed on market credit to the exclusion of other wealth creators.

Unfortunately for the regulator, robust risk management is not merely a function of capital adequacy. The idea of reducing risk by increasing capital is laughable: the boffins will simply find even riskier schemes to invest in. After all, how else can they make enormous returns and get their 8-figure bonuses?

This is why the Government is wrong to preclude breaking up the banks. Regulation is flawed because regulators are blinded in exactly the same way as participants when a bubble comes along, and because, for bankers, rules are made to be circumvented. The only way to manage the banks in the long-term is somehow to eliminate or mitigate moral hazard by allowing the market to apply its discipline.

Part of that market-based solution must be reducing banks' size and scope. Another part is regulation to make interdependencies more transparent, and to make banks pay upfront for the Government support implied by that. I somehow doubt that the living wills currently proposed will have the necessary teeth.

Indeed both ideas - King's "breaking up of the banks", and Turner's "increasing the capital ratios to reflect risk better" - are trying to do the same thing i.e. trying to arrange that the risks associated with a particular type of activity within a bank are linked to its capital make-up better.

However they approach the problem with two different philosophies, and this highlights some very substantial differences.

The latter Turner "just increase capital ratios better" approach is based on an elitist "we the the regulators know best" philosophy, and a "hey you ordinary person, don't worry your pretty little heads about this matter". It is going to be another Basel this, Basel that, formula worked out by a self interested group of bankers in Switzerland, which as far as the ordinary person is concerned, could be complete mumbo-jumbo contained within a black box. It excludes ordinary people and undoubtedly over time will be diluted and relaxed by banking vested interests lobbying power.

The former King "break up the banks" approach is based on a much more open democratic philosophy of "let the ordinary person see". The "people" will be able to understand this system of ensuring risk is separated up much better, and therefore very importantly they will be able to arrange their own behaviour accordingly.

While one might think that both approaches COULD achieve the same result, there are various reasons why the latter is an essentially fairer and more democratic route:
- the "just increase capital ratios" route will enable the mega banks to continue to hide subsidies for their proprietary gambling activities using depositors money, and the ordinary person will continue to be penalised on the returns he gets from depositing his money in a bank. In other words the gambling trader in the bank will never EVER pay a properly risk adjusted return for the money he is using, because he has more lobbying power within the bank than the ordinary depositor.
- over time the people will be able to more easily SEE when the vested interests are trying to tilt the playing field towards themselves. In the "capital ratios" system, all it takes is a chat with a few bankers in Switzerland, while if banks are quite separate, any change will be very visible to anyone. (In other words it will be much more difficult for the players to capture the regulators).
- and lastly, the breaking up the banks route will surely lead to more competition, which can only be good.

Why did the US, which is the only country in history (?) to have shown it has the guts to take proper action against huge monopolies and vested interests, break up the likes of Standard Oil and AT&T, rather than leave them as a monolith and get them to submit pricing formulas to a central regulator, start trying to work out what is an appropriate capital return for different parts of their business, try to assess risks here and there bla bla bla bla?

The "break the banks up" route is a far more democratic thing to do, and inherently gives "the people" more responsibility for their own actions, because they can understand what is going on better, and can make more choices.

The "just get a small group of supposed know-it-alls to work out better ratios" approach is a sort of mix of a fascist/communistic approach that "we know better than the people" and they can't be trusted to make decisions for themselves.

This latter aspect clearly explains why the Labour Government is so keen on it (.... well that and the fact that it is petrified of the power of the big banks).

I think there many issues are raised here. Firstly I think that the MPs committee desrve some credit for challenging what has happened in the UK.Having read the first poster on here then he too raises a valid point.

However I am reminded of the central tenet on this that I have read on notayesmanseconomics web blog on this issue and that is the matter of moral hazard. So far we have not dealt with this at all as the banks are again making profits much of whom is effectively being "given" to them by us the taxpayer with our monetary stimulus measures.So those who created the problem are being bailed out in many ways and we lack any real reform.

So anything that brings some reform would help..

# 1. At 02:06am on 29 Mar 2010, Leigh Caldwell wrote:

> Narrow banking would not have prevented the financial crisis.

This argument is often trotted out by those who don't know that it
takes two to gamble. If we make the right arrangements to allow the
speculative banks to go horribly broke with their own money, then
narrow banks would have no-one to go broke with, even if they do
have the Applegarths and the Lord Greedies of this world in charge.

# 2. At 08:19am on 29 Mar 2010, darksurfer wrote:

> A bank with poor risk management is a casino bank

So, a casino bank is one with poor risk management, eh?

But only when they loose. When they win, they say the risk
management was spot on!

The problem with Banks is that they are not very good at banking; but very good at making money for bankers. The major financial crashes have all been because of bad banking practices - driven by greedy bankers trying to make a lot of money. Because of this greed they have not lent wisely; monitored loans, done proper risk assessment and behaved in a socially responsible manner. The industry has invested in systems to make it trade faster and more speculatively; there are no real controls on this real time trading practice.

I agree that increasing capital requirement, moving to a principle based compliance system, making all the bankers (including senior managemement) be qualified, greater control over the banks risk profile and doing something about the daft wages they are paying themselves.

Nice to see the Treasury Select Committee still has teeth!

Narrow banking would have prevented Northern Rock and most of the banking failures in the last 24 months.

Northern Rock would never have been able to raise so much finance to fund higher risk 'together' mortgages which were essentially unsecured. Narrow banking would have required only a small percentage of higher LTV loans or raising 'money market funds' to finance the higher risk stuff, rather than using retail savings.

Halifax Bank of Scotland would only have been able to use ringfenced savers money for the lower risk mortgages and loans in its book. Investors in the riskier commercial lending would have demanded a much higher rate that would probably have prevented the lending in the first place (stopping the bubble), but these investors would also have lost when HBOS was rescued rather than passing the bill onto the tax payer.

The only people who are against narrow banking are those who have profited out of doing high risk activity ultimately underwritten by the UK tax payer using insured savings.

Given that banks have categorically proved that they are unable to manage risk effectively, it is up for governments to create some barriers in the system to avoid the tax payer being held to ransom.

For me a narrow bank is one that:

Maintains 15% of its assets in cash or AA+ rated government or bank bonds.

Maintains a Tier 1 capital ratio of at least 10%

Funds >50% of its business from retail savings

Has at least 90% of its customer loans secured on residential or commercial premises at less than 75% loan to value.

Sure a bank can still offer overdrafts, personal loans or loans to business. It just has to pay a proper rate to investors to do so and not use my current account or savings to undertake risky activity without me receiving a decent return or the government receiving an insurance premium for the privilege of insuring the savings.

There were no significant problems until the government relaxed banks' capital requirements, so for every £1 of capital they had they were allowed to borrow more money than in the past. I remember Mervyn King, in the midst of the housing boom, saying the BOE was aware of the housing boom but didn't want to damage businesses by raising interest rates. Look at the damage that's been done now! Of course, the bank/government could have acted to quell the boom by insisting on 20% deposits on mortgages at the time, but it didn't and so the boom carried on before inevitably the bust was bigger than it need have been.

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