Fear and Greed

The Interim Report of the UK Independent Commission on Banking was released yesterday.  In his opening remarks, Commission’s chairman Sir John Vickers enunciated three key points.

First, banks need to hold more capital.  According the Commission, the Basel III proposal of 7%–possibly more for especially large and important banks–is a step in the right direction.  The interim report see UK banks eventually clocking in at 10%.

Second, the report envisions a “ring-fence” around UK retail bank operations: banks that have interests beyond retail banking, such as investment banks, should not be allowed to let those non-retail businesses deplete the 10% capital held against retail operations.

Third, the report encourages the promotion of retail competition among UK banks.  The report singled out the Lloyds network of 2906 domestic branches (Lloyds also holds about 30 percent of all domestic current–i.e., checking–accounts). The bank already has plans to divest itself of 600 of those branches by the end of the year; the commission seems to indicate that a greater amount of divestiture is warranted.

These are all moves in the right direction.  According to the Financial Times, the banks–with the possible exception of Lloyds–breathed a sigh of relief that the proposed changes were not more extensive.

Managing a bank involves balancing two often-opposing forces: fear and greed.  Fear leads bankers to hold greater levels of capital and reserves.  These are costly to hold, but may spare the bank, not to mention the taxpayer, from the worst effects of a financial disaster.  Greed leads bankers to minimize these holdings in the search for more profit.

Imposing higher capital requirements is a way increasing the relative weight placed on fear.

Given the statement last week by Barclays chief Bob Diamond that the bank is looking to increase its risk profile in the coming months, the Commission’s emphasis on fear is especially timely.