Regular readers know that the issue of breaking up the banks is nothing more than a distraction. The real issue is requiring the banks to provide ultra transparency and disclosing on an ongoing basis their current global asset, liability and off-balance sheet exposure details.
It is only with this information that market participants can exert discipline on the banks and get them to refrain from excessive risk taking in both the retail and casino parts of the bank.
It is only with this information that market participants can assess the risk of each bank and adjust their exposure to each bank to a level that the market participant can afford to lose given the risk of the bank. It is this adjustment of each market participant's exposure that ends the risk of contagion.
As discussed by the Guardian,
In January 2010, the then chancellor, Alistair Darling, was asked about breaking up banks to make them safer. He had just pumped around £65bn of taxpayer funds in to the banks and replied: "I have always thought to separate banks doesn't deal with the full problem … It is the connections between institutions that cause problems not the legal entity. The large bank/small bank division, experience shows, does not answer the question either of Lehmans."The problem of connections between institutions can only be solved with ultra transparency.
It is the information that banks with deposits to lend need to independently assess the risk of banks looking to borrow.
It is the information that banks entering into a derivative contract need to independently assess the risk of the counter-party bank.
With the independent assessment of risk, the banks can adjust their exposures to each other to a level where they can afford to absorb the loss on their exposure without failing themselves.
Banks will do this because of market discipline. Banks that are at risk of failure from the collapse of another bank will see a much higher cost of funds and lower stock price than banks that are not at risk of failure from the collapse of another bank.
Roll on September 2012 and Labour, now in opposition and under new leadership, is baiting the coalition government for not going far enough in implementing the ringfencing proposals outlined by the Independent Commission on Banking.
Chaired by Sir John Vickers, who has expressed disappointment that the government has not endorsed the proposals in full, the ICB calls for a ringfence to be erected between high street banks and investment banks, dubbed casinos.Ring-fencing will do nothing to address the interconnectedness of the banks. Without ultra transparency, banks will still not be able to independently assess each other's risk, let alone tell which banks are solvent and which are not.
The shadow chancellor, Ed Balls, had made it clear in December that he would support what he described at the time as "these important banking reforms" and called for no "backsliding, foot dragging or watering them down".
By June, among the areas watered down was the leverage ratio – one of the ways to measure the risks banks take – and allowing the bits of the banks inside the ringfence to sell derivatives....This just shows that the Blob knows how to play the game. Get proposed regulations to focus on your issue and then lobby to get the regulations water-down.
Meanwhile, on Tuesday it is the turn of a panel set by European commissioner Michel Barnier to give its verdict on the merits – or not – of breaking up banks. The report by Erkki Liikanen, governor of the Bank of Finland, will be read closely by the heads of banks across Europe.The heads of banks across Europe will be looking to confirm that Erkki Liikanen restricts the discussion to breaking up or not breaking up the banks.
The heads of banks across Europe know they are in trouble if the question is asked if this is the most effective way to restrain risk taking or financial contagion.
Extraordinary, really, that four years on from the banking crisis politicians and policymakers are still arguing about the ideal shape for such a critical industry.
If you require high street and casino banks to provide ultra transparency, the market will figure out what is the ideal shape for the industry.