(Disclaimer: I own, or have owned, shares in some of the companies mentioned below)
There has been a lot of talk recently about breaking up the banks by separating their retail and investment arms—more so now that Vince Cable has a position in government. What makes me rather cross is that the politicians have clearly not looked at the banks which have failed in the UK and US:
Northern Rock: Lent too much money to borrowers in the hope that house prices would keep on rising. Relied too much on funding from the money markets instead of retail deposits and got caught out when these markets dried up. Did not have an investment banking arm.
Bradford & Bingley: Similar problems to Northern Rock, except it lent to people without asking for any proof of income. Did not have an investment banking arm.
Royal Bank of Scotland: Got into trouble by paying over the odds for ABM Ambro just before the credit crunch. Does have an investment banking arm, but that is currently profitable and was not the main cause of the bank requiring taxpayer support.
Halifax Bank of Scotland: Made too many dodgy loans to companies who could not pay them back, particularly in the property sector. Has some investment operations, but not at a scale which would cause a complete collapse.
AIG: An insurance company, not a bank, so does not take retail deposits. Got into trouble primarily by writing too many Credit Default Swaps (a form of insurance against default on corporate debt), which were activated when Lehman Brothers et al started to go under.
Lehman Brothers: Probably the most famous bank to collapse, caused partly by its inability to offload securitised mortgages before they started to default. However, it was not a retail bank, so depositors did not lose out as a result of the collapse.
Now let’s look at some of the banks which have survived the crisis more or less intact:
HSBC: Well diversified, both in terms of business areas and geography. Decided to raise capital through an early rights issue, and therefore did not need to tap investors for cash again and was able to pay dividends throughout the crisis. Has an investment banking arm and did not require bailing out by the government.
Barclays: Did not require a bailout from the government, instead tapping foreign investors for cash. Has a well known (and notorious for pay rewards) investment banking arm. Currently on the road to recovery and has reinstated its dividend.
In conclusion, most of the big bank failures were either pure investment banks, retail banks with no investment arm, or combined banks which were brought down by factors other than their investment operations. Some of the banks which survived the crisis also have investment operations, so the suggestion that combining investment and retail banking in one company is somehow a recipe to bring down the financial system is dubious to say the least.
I heard a very good argument for the split, but I can’t for the life of me remember what it was now 😉
But one might suggest that the reason to split is actually to protect against stupidity in not so well run banks. It alleviates the taxpayer from having to bailout one taking big risks with its investment arm to protect deposits.
What are the major arguments for keeping them together?
Major arguments for keeping them together are:
1. It would cost a lot of time and money to separate them (i.e. if it ain’t broke, don’t try and fix it).
2. It provides banks with greater diversification.
3. Depending on how the split was done, it could damage the value of the banks, which is not a good idea when the government owns large chunks of two of them and pension funds own chunks of the others.
In theory there’s no need for the government to bail out banks, they could just let them go bust, although if it happened to more than one at the same time that might damage confidence in the markets. Depositors are already protected under the Financial Services Compensation Scheme, which is paid for by a levy on financial institutions such as banks.
Yeah, but surely the major reason for bailing the (retail) banks is for consumer confidence. Which would be highly damaged by a high street bank going bust, loosing all your money and having to wait a few weeks for the process of claiming it back.