The Independent Banking Commission, led by Sir John Vickers, has the potential to be quietly revolutionary in the way it reshapes the banks. In its interim report in April it set out a coherent direction of travel. But it now has a huge challenge to articulate a set of detailed, cogent proposals and build a consensus around them. Moreover, the stakes are getting higher.

The 2008 crash occurred because the financial sector as a whole, and specific institutions within it, became over-indebted; because they took huge risks that they either did not understand or ignored; because those risks were assessed using standard models whose failure created a stampede when the crisis struck; because the banks in question were grossly under-supervised; and because governments, especially the UK government, became reliant on the banks for tax revenue and egged on the sector’s growth with loose monetary policy and light regulation.

What is really needed is a financial truth and reconciliation commission to analyse the crash, including the role of officials at the Treasury, the Financial Services Authority and the Bank of England, which were all deeply implicated. The Vickers commission is not that. But its interim proposals go to the heart of the sector’s problems. Non-retail arms of banks and investment banks should be able and allowed to fail; universal banks must ring-fence the balance sheets of their retail and investment banking arms, to insulate depositors’ capital from wholesale market risk; the banks should carry a minimum buffer of 10 per cent of capital, to prevent over-leveraging; balance sheets should have more capacity to absorb losses; and Lloyds must sell branches, to spur competition on the high street.

So far so good. But take the crucial idea of ring-fencing. This is an attempt to fillet the fish without damaging the flesh: to win greater financial stability without the high costs of fully separating retail and wholesale banking. Yet what does it mean? A low ring-fence might just be a few balance-sheet entries and a call to the regulator in order to move capital around. A high ring-fence might include separate staff, boards of directors and treasury functions, even separate trading brands. The issues are fiendishly complex. In testimony last week to the Treasury committee, the commission acknowledged it was still far from any conclusions.

Which lines of business would fall into each category? The commission suggests stipulating that certain lines, such as deposit-taking and small business lending, must fall on the retail side; others such as securities and derivatives origination on the wholesale side. There would be a grey area in the middle, policed by the regulator. But the potential problems are obvious: cheating, a huge need for expertise from regulators, little actual protection in a real crisis. The banks are already adept at reclassifying retail risk as wholesale and vice versa; and as the commission notes, the US still bailed out many mutual funds during the crisis, although these had been created precisely in part to avoid restrictions on retail deposits.

Finally, take the taxpayer subsidy currently being paid to the banks. The Bank of England has estimated this to be as high as £100bn per year during the crisis, and £57bn on average over 2007-09. The interim report estimated subsidy as “considerably in excess of £10bn”. How considerably? £20bn? £40 bn? Again, in its testimony the commission could shed no light other than saying it sought to reduce the subsidy to zero.

However, since no clarity means no consensus, clarity is vital. Bill Winters, a commission member, said major bank bonuses are generally 25 to 30 per cent of operating profit. So £10bn of annual taxpayer subsidy – call it profit – means £2.5bn plus of taxpayer funds going into unearned bank bonuses. It is hardly a surprise that taxpayers are still very angry about bank bonuses. This in turn suggests that the commission’s approach, which pays more attention to structure than to behaviour, may be flawed. More emphasis on wholesale competition, and more effective governance, is called for.

Last week Moody’s indicated it could downgrade 14 UK lenders. The stakes for the commission are dizzyingly high and are increasing.

The writer is a Conservative member of the Treasury committee

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