Speaking at the Which? Future of Banking Commission in London last week, King argued that the solution to the financial crisis is not one of regulation, but one of structure.
He said: “There needs to be water-tight ring fence in terms of capital and legal provision. We have been living in a fool’s paradise – we have been telling people that their money is completely safe yet the bank is taking part in risky activity.”
King said that by concentrating regulation on making sure that the most basic proponents of banking – i.e. retail deposits – are safe, there would be no need for Government bailouts and the markets would be able to decide whether banks live or die.
He said: “If we want retail depositors to have safe deposits then we have to make sure that the money is in safe hands. That means lower interest rates and a very clear guarantee, that can be done, but it cannot be done by alchemy.”
There is evidence in King’s favour – the largest deposit taker in the UK, Lloyds Banking Group, revealed impairments of £6.7bn in 2009 due to wholesale lending debts, accrued in part by using the £407bn of retail deposits. The Government was also forced to underwrite £19bn of retail savings held by Northern Rock for more than two years.
Institutions would also benefit from less risk – in 2009 many building societies saw their profits slashed thanks to spiralling Financial Services Compensation Scheme charges, which would become non-existent should narrow banks be able to guarantee their own deposits.
Building Societies Association director general Adrian Coles says he has a lot of sympathy for King’s arguments as building societies are already narrow deposit-takers. He says: “If ‘casino banking’ is not segregated from retail utility banking, it continues to be conducted by banks whose retail deposits are nevertheless insured by the FSCS, so transmitting these casino risks to all other deposit-takers via the FSCS.”
But universal banks argue that you cannot make money from narrow banking. Speaking in front of the Treasury Select Committee last month, Barclays chief executive John Varley argued that it was the universal banks that kept the economies of the world going round by using retail deposits to invest in everything from sovereign debt to carbon credits: “Narrow banks do not help the economy flourish,” he said.
The universal banks also argue that to create a narrow bank would mean to cover deposits on an unprofitable leveraged basis rather than a risk basis, so if the bank were to fail it has enough to cover the deposits invested into it.
In a speech in September 2009, UBS chief financial officer John Cryan argued a bank with a leveraged ratio would have to always make more from the capital held against the deposits than the deposits are making themselves. He said: “You certainly don’t want to be a deposit taker if you are governed by a leverage ratio – if we are measured ultimately on a 5 per cent leverage ratio, then we have got to earn a return on that 5 per cent capital of that deposit”.
As a result, Barclays Capital says: “Focusing on nominal balance sheet measures, such as leverage ratios, is in fact a deterrent to gather retail deposits”.
London School of Economics professor of banking and finance Charles Goodhart also thinks that narrow banking is not the answer. In a recent blog for the Financial Times he said that the “quasi” banks that would not fall under the ‘narrow’ category would be able to take part in risky investment and make bigger returns, free of regulatory burden.
He said: “Narrow banks inside the protected boundary will only be able to provide a lower return on deposits and worse financial services than those outside the boundary. So, during normal economic conditions there will be an incentive for savers to put their money with the unprotected, but higher yielding, institutions beyond the boundary. The narrow banks will, for the most part, wither on the vine.”
King’s arguments echo those of President Obama, who recently revealed the “Volcker Rule” to ban the propriatary trading of deposit-holding banks. But that plan is already being “watered down” by the US political process.
So can narrow banking ever work? It makes sense to limit risk against people’s money but the lower the risk, the lower then returns – will people sacrifice profits for guarantees?