December 6, 2023

Battle Starts Over British Bank Rules

On Monday, a volley will be fired at the country’s politically and economically powerful financial sector by a government-backed commission, which is expected to propose that Britain’s largest banks take steps to separate their trading and deposit-taking functions. That goes further than the financial reforms signed into law in the United States last summer, which do not draw as clear a line between speculative trading and more traditional banking services.

The proposals from the panel, the Independent Commission on Banking, will not be definitive; the commission is to produce a final recommendation to the government in September. But its expected recommendations on how to handle the systemic risks that large banks pose to the health of the economy represent a more direct challenge for British banks than the Dodd-Frank financial reform rules have been for American institutions.

While British regulators are expected to propose that banks make structural changes to defuse the threat from institutions considered too big to fail, their counterparts in Washington have focused on putting in place shock absorbers to mitigate the effects of another financial crisis. These American rules include making banks hold more capital to cushion unexpected losses and giving new legal powers for regulators to help failing financial institutions unwind in a way that does not threaten the entire system.

Despite all the complaints from Wall Street about Dodd-Frank, several British institutions have hinted that they might move their base of operations to New York from London. By contrast, the veiled threats by American banks that they might go elsewhere, voiced when the Dodd-Frank legislation was being debated, never gained traction.

Last week, Robert E. Diamond Jr., the chief executive of Barclays, issued a full-throated defense of keeping risky investment banking and safe deposit-taking under the same roof.

“It’s the model,” he said, “that’s enabled us to build a bank that’s diversified by business, by geography, by customers and by funding sources.”

But leaders of the commission have already called into question the argument — a core maxim of international banking — that universal banks like Barclays in Britain and Bank of America in the United States provide a public benefit because of their size, diverse range of services and ability to attract low-cost capital.

“In this regard,” John Vickers, a former chief economist for the Bank of England who is chairman of the banking commission, said during a speech this year, “it seems quite hard to identify and quantify real efficiencies as distinct from purely private gains.”

Mr. Vickers’s tone may be more subtle than the one used by the country’s chief bank critic, the Bank of England governor, Mervyn A. King, in arguing that banks in Britain are still too large for the country’s good. But the broader message is clear: the drive for profits in large banks surpasses the drive for efficiencies, resulting in actions that continue to pose a systemic risk to the national and global economy.

With the British banking sector much larger as a share of the national economy than its United States counterpart, it is no surprise that the debate has been more pointed in Britain than in Washington. The three largest British diversified banks — HSBC, Barclays and Royal Bank of Scotland — have assets that exceed Britain’s total economic output. At the same time, the government has majority stakes in R.B.S., and Lloyd’s, another large financial institution.

“This is a midsize country with an oversized bank system,” said Peter Hahn, a former investment banker at Citigroup who teaches finance at the Cass Business School in London. “We need to figure out a scalable bank system for the taxpayer to back.”

The most far-reaching proposal under consideration by Mr. Vickers’s panel would separate, or ring fence, the deposit-taking areas of the banks from their investment banking activities. The commission is not considering requiring banks to separate into independent companies, as happened in the United States in the Depression, but to operate as distinct subsidiaries with their own balance sheets belonging to a broader holding company.

That proposal, which would make it considerably more expensive to raise capital for investment banking, would be much more painful for Britain’s banks than the so-called Volcker Rule in the United States.

Under the United States approach, originally advocated in a stronger form by Paul A. Volcker, the former Federal Reserve chairman who served as an adviser to President Obama, banks’ freedom to trade with their own capital and manage hedge funds would be limited. But they would still be able to borrow money economically because their balance sheets would remain unified.

American regulators have been grappling with how to apply the Volcker Rule, and intense lobbying has been taking place. Banks would still be allowed to trade to serve customers — but not to speculate. Telling the two apart can be difficult, and banks have been hoping for clear dividing lines so they would know just how far they can go.

But some banks have spun off large trading operations, and American regulators have accepted that there will still be banks that are too large to fail. Efforts to define just what additional rules they will face are still in their infancy.

For some experts in Britain, the approach in the United States is simply not strong enough.

“In the end, you just can’t regulate these banks — they have too much money and too many lawyers,” said Andrew Hilton, the director of CSFI in London, a financial services research group. “We should be prepared to split the casino bank from the utility bank.”

After successfully diluting the toughest elements of the Volcker Rule before it passed, the banking lobbyists are now putting their effort into other parts of the Dodd-Frank law that could cut into profits at their lucrative consumer banking businesses.

Banks want to reverse, or at least delay, the adoption of new interchange regulations, which would cap what banks charge retailers to process debit card transactions. Last year, those fees totaled more than $20 billion.

The secondary target of banks is the new Consumer Financial Protection Bureau, an independent agency that will oversee nearly all consumer financial activity once it is up and running in July. Republicans in the House — whose most prominent local constituents are often community bankers — have introduced bills to cut back the bureau’s authority over mortgage loans and other consumer products.

Floyd Norris and Edward Wyatt contributed reporting.

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