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Ringing the changes: An EU-wide ring-fence?

Wednesday 14 December 2011 – by Karina Whalley & Andrew Hickley

As the UK considers moving towards a separation of investment and retail banking activities, European commissioner Michel Barnier has announced he is setting up a committee to look at applying this banking structure across Europe. Global Financial Strategy investigates the viability of such a structure.

Viral Acharya, an economics professor at New York University, says ring-fencing requirements are not the priority tool for preventing another financial crisis and should be looked at as part of a group of rules.

He said: “I have mixed feelings about it [ring-fencing]. They should keep reforms as a package rather than [looking at them] one by one. Sometimes reforms overall make sense even if for one individual thing you could argue this may or may not be the thing.”

Acharya, who is also a researcher at think tank Centre for Economic Policy Research praised the UK for focusing on “raising the overall level of capital standards” which he says is the “more important step overall”.

“Even commercial banks have got into trouble, not just in this crisis but in the past,” he said.

“So in that sense, the ring-fencing is not the first and foremost tool because even if you ring-fence you need to ensure commercial banks are capitalised and making good loans,” Acharya added.

“The idea that you want to save the commercial banking from some of the riskier activities it has some merit but I would just put precautionary wind on this whole approach.”

British Bankers’ Association executive director Paul Chisnall agrees with this view and cited an Adam Smith Institute paper saying ring-fencing is based on a misdiagnosis.

He told Global Financial Strategy: “The idea that you have to separate off investment banking services looks unusual when you bear in mind that most of the financial crisis failures in the UK actually were a result of retail and commercial lending not as a result of investment banking.

“We don’t think it is related to the financial crisis and we are surprised Europe would be looking at this,” Chisnall added.

The BBA head quoted from a European Central Bank report and from the European Banking Authority, which announced last year that universal banking is seen as a strength rather than a weakness as evidenced by the bank stress tests.

From the ECB’s findings, “experience shows that universal banks have been better placed to maintain credit lines than the more narrowly focused banks”, said Chisnall.

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