« Ponzi and pensions | Main | You can't escape demographics. Quit whining and deal with it. »

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

Cultural thing more than anything else, ring fencing is a very common term in the Uk, and has been for a long long time. As for Canada -- and your point is interesting, the reality is that Canadian banks take much less risk than their foreign counterpart. Its one of the few place that has imposed more stringent rules than those contemplated by Basel III (that the CEO of Citi is now calling "unamerican")

If you have a farm, and all the land is contiguous, you can put one fence right around your land, and keep all your stuff in and everybody else's stuff out. And you can get to anywhere on your farm without having to cross anyone else's land, or go on a public road. Farmers like that. I think that's the origin. My sister was the first person I ever heard use it in its original sense.

As I understand it when Canada removed the pillar separations we required at the entire bank, investment banking unit and all be under OSFI supervision and that the entire entity conform to OSFI banking rules, which are strict and high by world standards. It meant a chartered bank could own a riskier investment banking operation, but that investment bank could not be allowed to pose such a sizeable risk that it would undermine the chartered bank itself.

It seems that deregulation in the UK was used as an opportunity for British banks to take on more risk, period and we now know that risk was inappropriate.

It's often noted that the Royal Bank of Scotland and the Royal Bank of Canada were the same size in 1985. Culturally they were siblings too as they were both cut from the same tartan cloth. Canada's banking culture comes from Scotland.

But RBS went on a leverage binge and rapidly expanded its market operations, balance sheet and took off like a rocket. Its capital ratio was 4% at best. On the other hand RBC just went about like it always did, maintained a capital ratio of 7% or better and simply moved into other businesses with the expectation that they not increase the risk profile of the bank.

RBS had to be bailed out in 2008. RBC stayed solvent and reached the top of world banking, just by being themselves.

When I see the pain that Britain is going through it really makes me thankful for boring Canadian bankers. We are the refuge for boring, prudent Scots banking.

To get totally emotional the BMO will celebrate its 200th Anniversary in 2017 and it fully intends to be here for it. It will probably celebrate 200 years of prudent banking while it's at it.

At a glance it seems like 8 years is a ways out for implementing it. If that's the help and immunity they need then maybe 2019 won't do much good. By then there could be a lot worse problems that arrise if we don't take care of maintenance right now.

The first I heard of a financial ringfence was when GMAC (the finance sub of GM) partly sold off its mortgage business, Rescap, to raise capital after the auto crisis in '05. The ringfence was to protect rescap from being raided by its distressed parent. The irony of it all was that shortly after it was GMAC that needed saving from Rescap. We are always trying to protect ourselves against the last bomb that exploded.

Interesting post.

"Ring-fencing" is indeed a common term in the UK.

Re: higher costs, I believe (I haven't read the report, only secondhand sources) the report argues that higher costs arising from ring-fencing are dwarfed by the costs of bailouts.

Your question as to whether it's Canadian regulations or Canadian culture (which perhaps was created by regulations that once existed) is a great one. But didn't the US also used to have many more regulations? Because if so, those regulations either never produced the same risk-averse culture among bankers, or else the US bankers chucked that culture pretty fast once they were let off the regulatory leash (repeal of Sarbanes-Oxley, right?). I look forward to seeing other folks' comments on this.

In the long term, seems like you want both strong regulations, and a banking culture that buys into those regulations. I don't see how you get or keep a solid banking culture without having regulations, but if you don't have the right culture the bankers will push to have the regulations changed and will eventually succeed. How you achieve that ideal, stable cultural-regulatory equilibrium, or if Canada has (or had) achieved it, I have no idea.

Jeremy Fox,

"I don't see how you get or keep a solid banking culture without having regulations"

Market discipline. If people don't have to pay the costs of imprudence, they won't.

"if you don't have the right culture the bankers will push to have the regulations changed and will eventually succeed. How you achieve that ideal, stable cultural-regulatory equilibrium, or if Canada has (or had) achieved it, I have no idea."

I suspect absolute primal gut-wrenching terror is the best way to maintain bank regulation. It took about forty years before the bankers beat the American politicians, in the 1970s. The latter just didn't have that same interest that politicians who developed their views on banking in the early 1930s had. Maybe the key thing is not the banking culture of Canada, but the culture of the regulators, who (for whatever reason) have kept that vital absolute primal gut-wrenching terror (or something like it).

I don't think that banking is fundamentally from other businesses (the food industry is similar in many respects) in terms of the dynamics of regulation. It's a square; a country can do one of the following:

1. Tough regulation and market discipline. The ultra-safe model. Pro: nothing will probably ever go really wrong. Con: you get a hopelessly uncompetitive banking system and good finance has always been a necessary condition for sustainable industrialisation (and is arguably moreso in a complex modern economy).

2. Tough regulation and no market discipline. The post-Great Depression model. Pro: you get a system where no-one ever has to fear that they'll lose a high-street deposit, yet which is still safe. Con: bankers are a lot smarter than politicians and their incomes are more tied to beating the regulators than the regulators are to beating the bankers. I suspect that even Canadian bankers will have their day; like terrorists, the bankers only have to win once.

3. Low regulation and market discipline. The free-banking option. Pro: you get a structurally stable system that is both competitive and prudent, like Scottish banking in the 18th century. Con: there will be a lot of individual bank failures and the system is very dependent on social capital premiums.

4. Low regulation and no market discipline. We should all be familiar with this option by now; those of us in Britain and the Republic of Ireland certainly are. Pro: it's a great party. Con: it's a worse hangover.

There is a serious lack of any simple clear principle in the ICB report as to what goes on which side of the fence. See section 2.27 here:

http://bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf

For example they say that deposits from, and loans to large enterprises should be on the retail side of the fence. That doen’t sound like “retail” to me. Plus loans to “financial” firms cannot be made by banks’ retail divisions. I can see lawyers earning huge fees in squabbles over the definiton of the word “financial”.

Moreover, ring-fencing retail activities is plain illogical. For example some retail customers will want to have a flutter and expose themselves to risky investments, and why not? But of course they are not entitled to taxpayer support if it all goes wrong.

Second, and conversely, a proportion of non-retail customers, e.g. large commercial enterprises will want specific sums of money to be 100% safe. And if that’s what they want, there is no harm in that, as long as they don’t expect to get a commercial rate of interest on their money.

In contrast to the ICB’s deas, the “fence positioning” advocated by one of the submissions to the ICB (by Prof.R.A.Werner and others) makes far more sense. See:

http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

This puts the fence between 100% safe accounts and in contrast, commercial or “investment” accounts. That is, depositors large or small, can go for 100% safety, in which case their money is NOT used in a commercial manner. It is deposited at the Bank of England and thus earns little or no interest. Alternatively, they can let their money be invested in commerce. That means a higher rate of interest, but there is no taxpayer funded rescue if it goes wrong: it is not the job of taxpayers to subsidise commerce.

". . .or else the US bankers chucked that culture pretty fast once they were let off the regulatory leash (repeal of Sarbanes-Oxley, right?)"
FYI, Sarbanes-Oxley has not been repealed, and it was never specific to banks anyhow (it applies to all publicly-held companies in the US). Perhaps you were thinking of the Glass-Steagal Act?

Back on topic, what I don't understand about all these "ring-fence" sorts of proposals is how they are supposed to prevent a financial crisis like this last one. Throughout the crisis all the talk was of the collapse of the shadow banking system. It never really seemed like ordinary deposits at commercial were at risk. Is the claim that the collapse would have spread to commercial banking had it not been arrested? Even if you accept that premise, it seems like the ring-fence strategy will work only if we believe we can let the investment banks collapse, so long as commercial banks are protected. Does anybody believe that? It seems implausible to me. If the credit markets froze up when the investment banks started collapsing the last time around, surely they would do so again if the shadow banking system collapsed in a ring-fenced banking world, wouldn't they?

The comments to this entry are closed.

Search this site

  • Google

    WWW
    worthwhile.typepad.com
Blog powered by Typepad