Beyond Volcker

In Brussels last Friday, Philippe Lamberts MEP, a Belgian member of European Parliament's Green alliance, pulled off something of a coup by persuading three of the principal architects of financial sector reform to lead a debate entitled, ‘How to restructure the EU banking sector?’

Oxford academic Sir John Vickers, former US central banker Paul Volcker and EU internal market commissioner Michel Barnier were charged with outlining their visions for a safer banking system, based in part on a greater separation of activities, splitting for example investment banking from retail banking and proprietary trading from market making.

All three were supportive of the proposals brought forward in each other’s jurisdictions while carefully explaining why particular measures would not work in their own backyard. There will be no equivalent of the Volcker rule in the UK or Europe. There yet may be no Volcker rule in the US either given the number of objections and get-outs that have introduced since the most celebrated measure of the US Dodd-Frank act was first unveiled. But that’s another story.

Volcker talked of the UK approach as “parallel” to that taken in the US. Vickers’ Independent Banking on Commission seeks, among other things, to ringfence retail banking businesses from higher risk activities undertaken by units within the same group to prevent the British tax payer from ever again bailing out speculation. The Volcker rule has the same aim in mind when it limits US deposit-taking institutions’ ability to invest in hedge funds or private equity funds, or conduct proprietary trading activities. In Europe, Barnier promises to outlaw prop trading, a stance that may yet have implications for how MiFID II redraws the rulebook for dark pools operating in the region’s equity markets.

These measures are controversial enough. Banks invited to share the platform on Friday objected, for example, that ringfencing retail from investment banking in the UK failed the cost/benefit analysis test on grounds that it would cost a huge amount of money to achieve but probably would still leave the tax payer with a huge sum to pay should a systematically important bank topple over in the future. For the record, Vickers stoutly defended his proposals on grounds of cost.

But one of the debate’s participants wanted to go further. Eric de Keuleneer, a former head of corporate and investment banking at Generale Bank, a forerunner of Fortis, and now professor of finance and regulation at Solvay Brussels School of Economics and Management, argued that it was time to address the causes of a previous crisis, not just the GFC. The originate and distribute brokerage model had been a “disaster” in the 1990s, said de Keuleneer, pointing to its roll in the bubble that wiped billions off the value of the Nasadaq composite index when it burst in 2000. The means by which investment banks identified potential IPOs in Silicon Valley, then wrote glowing research reports that predicted stellar revenues, only to watch stock values to plummet soon after launch has uncomfortable associations with the way mortgages were repackaged and sold on to unsuspecting investors in the mid 2000s, precipitating the crisis. Now, the difficulties of the Facebook IPO have brought the excesses of the late 1990s still more vividly to mind.

De Keuleneer also asserted that while for commercial banks no major economies of scale exist above a certain size, investment banks’ influence and capacity for harm continued to grow the bigger they got. Size can be useful, he said, but also dangerous, noting the concentration of pockets of the credit default swap market with a handful of banks. When the pendulum starts swinging away from you, sometimes it just keeps going. Despite the fights over Volcker, further regulatory intervention to reshape banking business cannot be ruled out.