Should we break up the banks?

Why has dividing banks' retail and investment branches come back into fashion?
Investment banking
Commercial awareness

Getting divorced and moving house are supposed to be among life's most stressful experiences - and unfortunately, they have a habit of occurring together. UK banks are facing a version of this combination at the moment: as the immigration cap threatens to boot some of their top international talent out of Chelsea mews houses and into Manhattan apartments or Genevan lakeside retreats, they may also be forced to separate formally their corporate financial services and proprietary activities from the sections of their businesses which work with consumers.

Rock solid

At the end of last month, the Independent Commission on Banking, a body set up to consider reform to the UK financial services industry in the aftermath of the financial crisis, published its Issues Paper, a call for responses to various proposals which might make the UK banking sector more stable and more competitive. This preliminary statement considered the separation of retail and investment banking at length. This idea is not a new one; such a division was enforced in the US market by the Glass-Steagall Act in 1933 in the aftermath of the Wall Street Crash, and lasted in the US in various increasingly watered-down manifestations until 1999. Like bringing your own lunch to work and camel coats, the idea was once declared passé but has enjoyed a recent resurgence of popularity.

The main rationale for the proposal is that such a split would protect the deposits of consumers from being potentially put at risk by being used as collateral for the allegedly more speculative practices of investment banking. Some also claim that the move would help to prevent conflicts of interests and insider trading, and that splitting up financial giants like HSBC or the RBS Group into smaller players could promote competition in the sector.

The idea has gained momentum in recent weeks thanks to the appointment of Bob Diamond as Chief Executive of Barclays plc early this autumn. Widely regarded as the architect of the rise of investment banking division Barclays Capital in the decade from its founding to the beginning of the financial crisis and therefore a posterboy for "casino banking", his ascendancy to head the whole show provoked an outpouring of bitterness from those who see restrictions on financial activity as a logical reaction to the UK's current economic trials. Business Secretary Vince Cable was particularly prominent in the condemnation of the appointment and in continued calls for financial reform.

Hotfooting it

However, there have been many objections to such a split. Firstly, it can be argued that having retail and investment banking in one institution makes financial good sense as it potentially allows a healthy profit to be achieved for retail products. Also, investment banking activities facilitate the hedging strategies which actively increase the safety of consumer's money while held in banking institutions. In addition, enacting such a split could lead to certain banks moving their headquarters overseas: for example, it has been suggested that HSBC's management might choose to head swiftly back to Asia, where the bank's roots are.

In this debate, the political dimension should not be overlooked. Public opinion against bankers and a perception of them as dangerously risk-prone remains strong and so measures which appear to constrain them are guaranteed to be approved by certain sections of the electorate. Cable's advocation of increased banking regulation seems to have done almost as much for his popularity with the public as the revelation that he is a keen ballroom dancer.

So perhaps the threat of separation should be regarded as an emotional tactic rather than a real possibility. Even Cable has been reported as advocating subtle over crude methods of regulation. One less dramatic solution mooted is the establishment of banking "firewalls". This measure would mean that different businesses within a bank would be turned into independent legal entities, regulated separately and with their own funding structures. So rather than parting company completely, the investment and retail arms of a bank would remain under the same roof but with little communication or involvement. Such an idea has been presented by some as a best of both worlds solution that avoids dividing universal banks, but controls the risks that they represent. But this uncomfortable cohabitation of entities leading separate lives is likely to feel the same to banks as a full divorce, who will not be consoled by the prospect of continued sharing of technology or HR functions. However they, and everyone else, will have to wait for action in the UK on this issue until the Independent Commission on Banking produces its full report in autumn 2011.

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