Vol 9 (2012) - Issue 2

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The Vickers Independent Banking Commission Report – Does the Ring-fencing of Retail Banks Mitigate Systemic Risk Concerns in the Banking Sector?

Introduction

Monitoring 'systemic risk' has become an important regulatory objective in the wake of the global financial crisis. The Bank of England and Financial Services Authority (FSA) have identified that systemic risk may be manifest in two distinct ways, viz

– (i) the amount of risk that the financial system takes at a point in time relative to its capital and liquidity resources ('time-varying' or 'cyclical' risk); and
(ii) for a given amount of time-varying risk, structural features of the financial system, such as its connections and the distribution of risk across different participants, which create or exacerbate vulnerabilities ('cross-sectional' or 'structural' risk).

'Structural' features of the financial system that may create or exacerbate 'systemic risk' include connections and linkages between financial institutions that could cause contagion failure if an institution fails. Such 'connections' could also be internalised, as in the case of large and diversified financial groups where losses occurring in one entity may threaten to bring down the group if the magnitude of loss becomes significant, such as in the case of the American Insurance Group in the US.
It has therefore been proposed that regulatory attention be given to large universal banking and finance groups, or 'Systemically Important Financial Institutions' (SIFIs) due to their potential contribution to exacerbating or creating systemic risk. The Basel Committee has worked on identifying the features of a SIFI, by developing a set of 5 equally weighted indicators to be applied to banking institutions, including size, linkages, global footprint, complexity and substitutability of services, and the Financial Stability Board has also recommended a list of SIFIs for regulatory attention.
This short commentary intends to examine the UK Independent Banking Commission’s Report (Vickers Report) in light of the move towards mitigating systemic risks posed by SIFIs. The Vickers Report positions 'structural' reform as proposed in the Report as contributing to the financial stability objective of UK financial regulation, and 'greater resilience against future financial crises and removing risks from banks to the public finances.' 'Structural reform', which in a nutshell refers to the ring-fencing of retail banking from investment banking activities, is intended to remove the connections between retail and investment banks8 so that retail banks which serve purposes of social utility would be insulated from systemic risk shocks as far as possible.
Part I discusses the key features in the Vickers Report’s structural reform (omitting some of the other recommendations in the Report dealing with depositor preference and competition). Part II critically considers if structural reform would be effective in mitigating systemic risk concerns. Part III concludes.