Following the financial crisis there have been numerous alternative ideas as to how to limit the negative externalities of a failing firm, they range from the complete restructuring of financial institutions on a structural basis, to simply altering current practice. One theory that has gained substantial support in recent times is the separation of retail and trading arms of financial institutions, the so called ‘Narrow Banking’ approach. Narrow Banking theory purports that separating the utility forms of banking, deposit taking etc which would have justifications for protection under FSA statutory obligations, from the riskier forms of wholesale banking.
Fundamentally this would create a new Glass-Seagall concept of narrow banking as seen in the US prior to the 1980’s/90s. Professor Kay proposes an extreme narrow banking model, in which banks take in insured retail deposits and provide retail payments systems invest all of their assets in government bonds.111 This would reduce the size and inter-connectedness of financial institutions
making them less systemically important and therefore reducing the risk of larger systemic problems if a firm were to face financial difficulty.
The problems of large interconnected financial institutions has been well documented above and does not need to be reiterated, however there are some arguments against separating/restructuring large financial institutions. In particular there are perceived to be a number of significant benefits to the establishment of large interconnected organisations.112 The BBA are against such a restructuring
as they perceive that
‘[…] requiring large banks to radically alter their business structures may limit their ability to service large global clients and would inevitably increase operating inefficiencies resulting in a further source of cost for end-users.’113
Interesting to note Lord Turner spent some time discussing the area, whilst noting that an extreme narrow banking model, with retail banks investing only in government securities, was certainly practical but failed to address the crucial issue of booms and busts in credit supply and as a result,
111 John Kay, ‘Narrow Banking: the Reform of Banking Regulation (2009) accessed at
http://www.johnkay.com/wp-content/uploads/2009/12/JK-Narrow-Banking.pdf [accessed on 17 September 2014].
112 House of Commons Treasury Committee, Too important to fail- too important to ignore (n 107)38. 113ibid 38.
40 | P a g e could actually increase financial instability. He argued that all the objectives behind such a
separation were most definitely desirable but could be achieved much better with the designation of appropriate capital requirements and the use of resolution and recovery plans to drive internal distinctions between retail and trading activities.
‘It is essential to progress this argument beyond the top line slogans, for or against narrow banking, and get down to details. The extreme narrow banking proposal is clearly doable in practical terms, but I believe could produce a financial system even more vulnerable to instability than the one we have today. In contrast the ‘new Glass Steagall’ divide is in principle attractive, but arguably best pursued through the capital requirements we place on trading activities rather than through an attempt to write a law prohibiting some activities and allowing others.’114
One idea that was forward as an alternative was a form of trade-off between completely
restructuring financial institutions, and allowing massive institutions to continue to operate in the same way as they currently did. This was proposed through the establishment of a capital surcharge for systemically important banks, this surcharge would be lower for those groups which go further in the direction of clear legal separation of different activities.115 It would then give the institutions
themselves the option as to whether they wished to either restructure or fund a surcharge that could aid in if the institution entered financial difficulties.
Ultimately this was largely ignored by government in favour of the establishment of retail ring- fencing under the Financial Services (Banking Reform) Act 2013. The Financial Services (Banking Reform) Act 2013 introduced a ‘ring-fence’ of retail deposits defined as ‘core activities’ under the act from wholesale or investment trading activities.116 The intention of the act was to ensure that those
banks that are carrying on retail activities will be capable of carrying on the business of providing the core services related to the acceptance of deposits independently of other services in the banking group.117 The new legislation awards new powers to the PRA to restructure banking groups and
divest shares in ring-fenced banks from parent companies.118 This level of invasive regulation is
entirely new and will be interesting to see if the regulator will exercise those powers. The viability of
114 FSA Press Release, ‘FSA chairman says 'no silver bullet' to address 'too-big-to-fail' challenge’ (FSA/PN/148/2009 02 Nov 2009).
115 House of Commons Treasury Committee, Too important to fail- too important to ignore (n 107) 38. 116 Financial Services (Banking Reform) Act 2013 Explanatory notes.
117 Financial Services (Banking Reform) Act 2013. 118 ibid s.4(1).
41 | P a g e such a provision has been unproven to date, and it will be interesting to monitor the suitability of the legislation over the coming years.