6 Barriers to exit
Too important to fail—too
big to compete against?
217. The ICB's remit goes beyond competition to the
structure of the banking system. The two are intricately linked.
For there to be healthy competition it is important that there
is, as far as is possible, a level playing field for all competitors.
As we noted earlier, the important issue is that banks that are
seen as systemically important and perceived as too important
to fail may receive an unfair advantage. The Governor of the Bank
of England explained in a recent newspaper interview that he considered
there was still a problem that needed to be solved. "We've
not yet solved the 'too big to fail' or, as I prefer to call it,
the 'too important to fail' problem. The concept of being too
important to fail should have no place in a market economy."[342]
Lord Turner in evidence considered that this was an issue that
needed examining.
A problem that we have to fix is that where there
is a perception that some banks are too big to fail, they might
clearly—and this is more to do with corporate customers
and institutional investors—have a slight funding advantage,
because people will deposit money with them at a lower price than
they would with smaller banks. That's not the case, of course,
at the retail customer level, because deposit insurance tends
to even out the playing field for them.[343]
218. Jayne-Anne Gadhia also considered that this
was an issue and told us that "we have to make sure that
there is no bank that is too big to fail. I do believe, therefore,
that banks should be smaller than the very big banks are today."[344]
She also believed that this was an issue that directly affected
the competitive landscape.
I think that switching of banks has become even
less over the time of the crisis and that's been unfortunate.
As trust has been eroded, I think people have been less ready
to take the risk of switching accounts, so that, perhaps, has
locked the market still further. I think, too, that when customers
effectively get a sovereign guarantee on a big bank, why wouldn't
they put their money in that bank while the market is in flux?
I think that, as a consequence of the necessary response to the
financial crisis—I have to say clearly, in terms of financial
stability, it was very important—competition and the movement
of customers have been reduced.[345]
Clive Maxwell from the OFT explained that if market
participants couldn't fail the impact of competition would be
limited.
If you look at competition, the impact of competition
is felt first within a firm, and it forces its management to think
differently; second, you have rivalry between the firms that exist
in the marketplace; and, third, you have a potential for bigger
dynamic change from new entrants coming into the market with disruptive
technologies. I think if you have an absence of exit from a market
it makes the second and third types of competition much less likely
to occur.[346]
The Financial Services Consumer Panel also considered
that there was a problem that needed to be resolved so that small
or new entrants could become real challengers.
If the market is to be opened to more new entrants
there needs to be resolution of the implicit Government subsidy
of banks that are "too big to fail." This distorts competition
by weakening the ability of small or new entrants to become real
challengers and destroys the functioning of an effective market.[347]
Bob Diamond considered that Barclays was not "too
big to fail" but explained that it was the diversification
of their universal banking model which helped them be financially
stable.
No, I don't think Barclays is too big to fail.
That's the simple answer; let me give a little bit more colour
around it. I think the business model that we employ of the integrated
universal banking model is an important starting position. It
gives us great diversification of earnings, great diversification
of our clients, but also great diversification of our deposits,
both institutional and retail, and of our funding sources; we
just raised money in dollars in the US late last week. So that
diversification is a very important part of being financially
stable.[348]
219. The Bank of England's Financial Stability report
of December 2010 highlighted the subsidy available for the most
important financial institutions.
The distress or failure of a systemically important
financial institution (SIFI) is likely to entail large-scale economic
costs. These costs engender expectations of government support
and so allow SIFIs to benefit from an implicit funding subsidy
from taxpayers.[349]
The report provided a chart which gave an estimate
of government subsidy for banks and building societies in 2007,
2008 and 2009.
Figure 2: Estimated size of total implicit funding
subsidy to UK Banks and Building Societies split by size (a)(b)(c)
(a) The implicit subsidy is calculated by comparing the difference in funding costs calculated at end of year for individual UK banks and building societies, based on the difference in the average funding cost of UK financial institutions rated at the support rating and the average funding cost for UK financial institutions rated at the standalone rating. This difference is then multiplied by the rating-sensitive liabilities of the bank or building society.
(b) Rating-sensitive liabilities are defined as deposits from banks and other financials, financial liabilities designated at fair value, debt securities in issue (excluding securitisations) and subordinated liabilities.
(c) The 'large' category includes Barclays, HSBC, Lloyds TSB and RBS. The 'medium' category includes Nationwide and Northern Rock (until 2008). The 'small' category includes Chelsea, Coventry, Leeds, Principality, Skipton, West Bromwich and Yorkshire building societies.
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Source: The Bank of England's Financial Stability
report, December 2010
In each year the total subsidy for the large banks
was the largest and in 2009 it was estimated to be over £100bn.
However in 2007 and 2008 the medium sized banks and building societies
(which included Northern Rock) were judged to have received the
most subsidy relative to the size of their non-derivative liabilities.
Interestingly in all years the small banks were judged to have
received the lowest subsidy in proportion to their size.
220. We asked the Financial Secretary about this
large subsidy and the implications for competition. He agreed
that there was a "legitimate argument" that it lead
to problems for other competitors.
I think there is an argument about the extent
to which it undermines competition in the sense of whether there
is an uneven playing field that that implicit support enables
them to operate to the detriment of other players in the market.
I think there is legitimate argument there.[350]
He outlined four possible solutions to the problem.
You can have global capital surcharges on SIFIs,
which is one way of doing it; you could go through subsidiarisation;
you could have a split between retail and wholesale banking; or
you could decide to do what Paul Volcker suggested, which was
split off proprietary trading, which is a variation on the theme
of Glass-Steagall.[351]
221. Sir John Vickers in his speech of January 2011
explained that one of the areas which the Independent Commission
on Banking was looking at was the ring-fencing of retail banking
from investment banking activities:
One response to this concern could be somehow
to ring-fence the retail banking activities of systemically-important
institutions and require them to be capitalized on a stand-alone
basis. A variant of this idea would be to require the ring-fenced
retail banking activities to be relatively strongly capitalized,
while adopting a lighter regulatory policy towards the other activities
(if any) of banks, thereby focussing (and limiting) the need for
heightened capital requirements on the key retail services.[352]
222. Banks which are seen as too important to
fail are also too big for fair competition. They receive an implicit
subsidy to their funding costs placing them at an unfair competitive
advantage to other smaller and less systemically important banks.
It also means that providers who offer poorer quality or over-priced
products face little threat of being forced out of the market,
as they would do in any other industry. Solving the too big to
fail problem is critically important from a competition as well
as a financial stability perspective. The Independent Commission
on Banking must address this problem which is crucial to achieving
the objectives outlined in its terms of reference. We are encouraged
by signs that it is already considering ring fencing as a possible
solution which would provide a more level playing field to all
market participants. Furthermore, we expect the Government to
respond to our predecessor Committee's Report on this issue when
it responds to the ICB.
342 The Daily Telegraph, We prevented a Great Depression...
but people have the right to be angry, p5 Back
343
Q 78 Back
344
Q 629 Back
345
Q 642 Back
346
Q 775 Back
347
Ev 230 [FSCP] Back
348
Q 518 Back
349
Bank of England, Financial Stability Report, Issue No.28,
December 2010, p.51 Back
350
Q 1097 Back
351
Q 1100 Back
352
Sir John Vickers speech, How to regulate the capital and corporate
structures of banks?, 22 January 2011 Back
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