ICB's proposals for higher bank capital could backfire

Prof Philip Booth comments on the ICB's proposals

Responding to the Independent Commission on Banking’s interim report, Prof Philip Booth, Editorial Director of the Institute of Economic Affairs, said:
 
"Whilst some measures suggested in the report are welcome, the ICB focuses too much on regulatory mechanisms to ensure that banks have sufficient capital to prevent failure. A competitive market requires banks to fail and their orderly failure should be the key objective of reform. It was also disappointing that the important issue of the over-taxation of equity capital, flagged by the Chairman of the Commission Sir John Vickers in a recent speech, has been side-lined."
 
Some of the proposals in the Banking Commission's report are welcome. However,
 
1. The Commission have placed too much emphasis on regulatory mechanisms to reduce the probability of failure and not enough on market mechanisms.
 
2. The Commission’s proposals for higher capital requirements will run directly contrary to its desire for more competition. Higher capital requirements would make failure less likely and would therefore entrench large firms. Capital requirements are also a barrier to entry for new firms.
 
3. Making failure less likely is much less important than ensuring that failures can be managed in an orderly fashion. As such, more work needs to be done on the precise legal framework that is used to wind up banks that have failed. This is the key to a competitive and stable banking system.
 
4. Subsidiarisation has some merits when it comes to ensuring orderly failure. However, it should not be regarded as a panacea and can increase risks. Governments have also shown that they are willing, unfortunately, to bail out institutions that are not connected to the payments system. It is important that we can wind up insolvent retail, investment and universal banks in an orderly fashion. Subsidiarisation should not be used to ensure that retail banks never fail.  Only those banks that cannot demonstrate how they could be wound up in an orderly fashion should be required to subsidiarise.
 
5. It is very disappointing not to see the over-taxation of equity capital mentioned as a substantive issue especially as Sir John Vickers raised this issue in a recent speech.
 
6. The use of risk-based deposit insurance is also essential. Banks could have more freedom with their capital structure if it is understood that their deposit insurance costs will vary with their capital structure.

 

To arrange an interview with Prof Philip Booth, IEA Editorial Director, or Mark Littlewood, IEA Director General, please contact Ruth Porter, Communications Director, 077 5171 7781, 020 7799 8900, rporter@iea.org.uk.

 

Notes to editors

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