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Bank competition and Vickers

    On Monday, the Vickers Commission  made its preliminary recommendations on potential banking reform. There is much to welcome, in particular an increased focus on the need for more competition in the retail banking sector, as proposed by Andrea Leadsom . Likewise Howard Flight was making Vickers’ case for something similar to the implied firewall between commercial and investment activities in 2008. He said:

    “the moral must be that commercial banks should at least be limited in the extent to which they can participate in investment banking activities and instruments which can wipe out capital.”

    It strikes me, however, that the proposals outlined fail to address several key issues relating to competition.

    Firstly, the proposals ignore a central conundrum the FSA will face – namely, the proposal for banks to be overly capitalised will in itself represent a significant barrier to entry for potential new banks. Secondly, it does not address the issue of new, smaller banks not being afforded the same ‘lender of last resort’ function as larger institutions. At the moment smaller banks do not appear to be covered by the Bank of England (just look at the example of Barings) but they are often the ones which lose deposits first. This leaves them at a major competitive disadvantage compared to larger institutions, and helps to compound the moral hazard problem.

    Whilst a more competitive retail banking sector would be a good thing, it will not end the risk of bank runs or the moral hazard problems of existing banks. The key, as the IEA have so eloquently put it, should not be to try to lower the risk of failure but instead to make sure failures are managed in an orderly fashion. The retail/investment bank firewall will help to a certain extent, but it is unclear whether governments would have the courage not to bail out wholesale or investment banks in future, given their huge size and influence on the domestic economy.

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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