This suggests that a better question is whether to introduce the Volcker rule in addition to, rather than instead of, ring-fencing. In the interest of simplicity, I would say no.
Enforcing total separation instead of ring-fencing would provide a stronger barrier, but at a potentially high cost, including a risk to financial stability. After all, full separation implies that resources from elsewhere in a given banking group are unavailable to address a retail-banking crisis resulting from, say, a slump in residential and commercial property prices.
Such crises can happen. So the ICB concluded that its reform package for the UK would achieve the main aims of full separation at a lower cost, and without creating the risk to financial stability that could come from having undiversified, correlated, stand-alone domestic retail banking. To be sure, the success of this approach depends on the fence staying strong. That requires good initial design and constant regulatory vigilance, but so does full separation.
Structural reform of banks does not solve all problems. However, at least for the UK and the rest of Europe, it is a key part of the overall reform package, along with much stronger capital and liquidity standards, loss-absorbent debt (including “bail-ins” by creditors), real resolvability, and so on. There is also the question of how to protect financial stability from risks arising from shadow banking, including the risk of contagion to traditional banking, which ring-fencing helps to contain.
Structural reform is also fundamental to the moves toward a European banking union, for a union with well-capitalized and safely structured banks has much better prospects than one without. Otherwise, mutualization of contingent liabilities could exacerbate the too-important-to-fail problem.
Now that structural reform is explicitly on the agenda, the debate about European banking reform is entering a new phase. However, as the IMF has stressed, the debate needs to go beyond Europe. Moreover, it is more than a debate about public policy, because, in the post-crisis world, market incentives might point toward forms of separation between retail and investment banking.
Market incentives surrounding various business models will remain distorted so long as taxpayers are liable for bank losses. That provides all the more reason to get them off the hook via structural and other banking reforms.
John Vickers is a former chief economist of the Bank of England and a former member of its monetary policy committee, and was chairman of the UK’s Independent Commission on Banking.
Copyright: Project Syndicate