Sir Vickers on Banking Reform in the UK - and the legacy of the Financial Crisis

Thursday, Sep 29, 2016
by vrosenth

Like the vast majority of his fellow economists, former Bank of England Chief Economist Sir John Vickers acknowledges having had no special premonition of the financial crisis in 2008 and of having been blindsided by the severity of the crisis and its impact on the banks and the financial system. Remarking on the ferocity of the downturn, the surprise, said Vickers, was not so much the collapse of Bear Stearns in March 2008 but the “shock of the shock”—the effect that the shock would have not just on the US alone but on the banking and financial systems in the UK, Europe and the world.

That impact continues to reverberate, says Vickers, currently Professor of Economics at Oxford University. In a lunchtime talk to a packed audience in Dodds Auditorium, Vickers, who chaired the Independent Commission on Banking formed by the British government to recommend steps to avert future crises, talked about how and why the UK banking system failed during the global financial crisis, and the commission’s recommendations on how to reform Britain’s banks to create a more stable and competitive UK banking system long term.

His experience— as an academic, as a regulator helping set monetary policy, and as chair of the commission tasked with offering a set of pragmatic, doable recommendations for reforming the banking system—has provided him with a unique perspective on the present state of the banks and of reform in the UK; it’s the perspective of an academic and someone who’s served in the trenches. Moreover, reforming the banking system, he warned, remains unfinished: Basel III framework is too weak; Europe may continue to kick the can down the road rather than undertake structural reform of its banks; and Brexit represents a wild card that has heightened risk.

To provide context, Vickers gave a quick overview of the banks, discussing the run-up in UK bank leverage beginning in the 2000s and the large role played by banks in the UK (and in Europe): Domestic banking assets as a percentage of GDP in the UK was about 450 percent (versus 100 percent in the US); individual banks, while huge, were thinly capitalized with a thin sheet of equity and non-loss-absorbent debt; and the financial system was highly interconnected, both within and between the banks, with no fire  breaks. Vickers has little doubt that the taxpayer bailout and rescue of the banks was necessary and unavoidable, given the tools available to the government and regulators. Recovery from the crisis has been weak: output took nearly six years to recover to pre-crisis levels; unemployment rose; and productivity growth has been lackluster.

In its recommendations, said Vickers, the Independent Commission was mindful of what was feasible given its mandate, which was to consider structural reforms to the UK banking sector, promote financial stability and competition between banks, and address the issues of UK competitiveness and fiscal risk. The best way to achieve those aims was to combine moderate measures focused on loss absorbency and structure, rather than taking radical measures. The commission recommendations focused on: ring-fencing the plain vanilla retail banking activities of the bank from the more speculative trading and market-making activities and increasing the capacity of the banks to absorb losses by increasing the levels of tier 1 equity capital, reducing the amount of leverage and creating loss-absorbing debt, and giving depositors preferential status in a bank insolvency.

In his concluding remarks, Vickers cited Bank of England’s Governor Mark Carney, who claims that “the job [of bank reform] is now substantially complete”—a view Vickers rejects. If anything, much work remains to be done:  Basel III is weak on leverage; the BoE has been lax on capital requirements; Europe has failed to address serious structural reform; and Brexit has put the future of London as the finance capital in doubt.

To be sure some of the recommendations are about as thrilling as shopping for insurance. But as he noted, “I think that if you can avoid these crises, then you should do it—you’d be happy to pay that insurance premium to achieve that.”

The slides to Vickers’ talk can be found here.  To learn more about optimal equity capital requirements, read Vickers’ The Systemic Risk Buffer for UK Banks: A Response to the Bank of England’s Consultation Paper that appeared in the Journal of Financial Regulation

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