RBS's Hester slams British bank reform plan for moral hazard risk

Stephen Hester, chief executive of Royal Bank of Scotland, criticized ring-fencing for creating a moral hazard risk under which the retail part of the bank is always bailed out.  He argued that the goal of financial reform should be to end bailouts for either investment or retail banking.

Regular readers know that the way to end bailouts is to require banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants can independently assess the risk of each bank.  Market participants can then use this assessment and their capacity to absorb losses to determine how much to have exposed to each bank.

This effectively ends contagion and the excuse for bailing out the banks.

Regular readers recall that a modern financial system is designed so that the banks do not have to be bailed out.  Hence, the reason that Wall Street and the City had to invent the excuse for bailing out the banks.

The reason that banks don't have to be bailed out is the combination of deposit insurance and access to central bank funding.  With deposit insurance, when banks have low or negative book capital levels taxpayers become their 'silent equity' partners.

With the taxpayer already supporting the banks with low or negative book capital levels, there is no reason to convert this support into an 'investment/bailout'.

As reported by the Guardian,

Britain's plan to force banks to shield their retail operations from riskier activities could create a moral hazard from the expectation that lenders will be bailed out if they hit trouble, a top banker said on Monday. 

Britain is forcing banks to safeguard, or "ring-fence," their domestic retail operations to better protect taxpayers and depositors in case a bank's investment banking and other trading activities run into problems. 

"The language of ring fencing has huge risk of moral hazard," said Stephen Hester, chief executive of Royal Bank of Scotland. "You are giving a charter in everyone's minds for the next time there is a problem inside the ring fence, (the bank) gets bailed out by one mechanism or another." 

"I have a big worry about the moral hazard," he told MPs as part of an inquiry into banking standards and industry reforms. 

In the past the "vast majority" of banking problems have been in retail banking, he said. 

"You are also letting a common currency that one part of financial services is more important than another. These are big mistakes," Hester said, adding that authorities should be aiming for a system in which no part of a bank is bailed out.... 

Peter Sands, chief executive of Asia-focused bank Standard Chartered, was critical of the concept that part of a bank could be shielded from trouble in another part. 

"I am pretty sceptical of the benefits of ring-fencing. The notion that one bit of the group could get into trouble and the other bit would be unaffected is unlikely to hold. People would be very wary of how that worked," he told the MPs. 

In a submission to the inquiry, Standard Chartered said it had concerns that creating extra intra-group requirements will make banks "more brittle and unable to deal with relatively minor funding problems".