The Bankwatch

Tracking the consumer evolution of financial services

Is the utility bank/ risky bank model workable?

Martin Wolf makes a persuasive argument that regulatory division between financial utilities and risk takers (casinos in his words) is impossible.

Why curbing finance is hard to do | FT Martin Wolf

First, the border between utility and casino banking is impossible to draw. For Mr Kay, the utility is the payment system and protection of deposits. This would leave all lending – including to households and businesses – inside the casino. For those in the US who hark back to the Glass-Steagall Act, the distinction is between commercial and riskier investment banking.

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Mr Kay’s distinction is clear, but problematic. If we followed him, all risk management would become unregulated. It is inconceivable that governments would, or could, leave them so. If we moved back to a Glass-Steagall distinction (itself never accepted in continental Europe), we would need to draw a line. But where? Why would lending to households and business be good, but securitising those loans bad? Why would hedging be good, but speculating bad and how might one draw the line between them?

I disagree. It is hard but not impossible. From inside a bank it is abundantly clear where the distinction lies, so there has to be a way to draw up the rules. Personal mortgages funded dollar for dollar directly against retail deposits for example with no securitization vehicle in between would be a good place to begin. The inevitable argument would be that without access to alternative securitization activities that consumer credit would be more expensive. Well recent experience would suggest stability over extreme discounts would be a good thing. There could be two types of mortgage offerred by utility and by risk banks. This would be a fascinating comparison.

At the other end of the division Mr Wolf draws we have clear investment banking activities funding large corporates with obscure investment vehicles.

The difficulty would lie in the middle range of products as to whether they are utility or casino. The rule would be best served to keep them in the casino until they can be shown as deserving to be in utility. No amount of debate will solve this – it would require draconian regulation driven by speaking to regular bankers, not investment bankers.

Finally the drive from consumers towards utility or riskier banking products would be the ultimate measure. Bearing in mind that the offerors of the risky products would have no government backing, this would be reflected in the price and the nature of collateral they would require. The final piece of this puzzle is the extent to which the utility offering banks have deposit insurance, and government assistance. They should in my view have deposit insurance to a limited dollar value, but should not be government owned.

It is a journey worth beginning, and should not be written off lightly as this Wolf piece does – the future stability of consumer economy depends on it.

Written by Colin Henderson

October 23, 2009 at 00:51

Posted in Uncategorized

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