The Independent Commission on Banking made its final report last month. As the Government considers what action to take, it must be remembered that the ICB is a body that recommends, not a body that decides. 

Nevertheless, the Commission’s intentions are worthy ones: to guard against future crisis through extensive reform of the industry, while protecting a banking system that is effective, efficient and secure for its customers. To achieve this, the ICB proposes a retail ring-fence, more loss absorbing capital and more competition in retail banking. I’ll focus my attention here on those first two propositions.

There are already requirements for banks in the UK to follow recovery and resolution plans. The retail ring-fence is quite a different proposition.  It may well reduce a retail entity’s exposure to untenable losses in the wider group. But that firewall comes at the cost of upping organisational complexity – this could be detrimental for business customers in more ‘normal’ times. And whilst life may still be uncomfortable at present, periods of normality are far more usual than times of crisis.

With a ring-fence in place, the bank loses the benefits of diversification. This can work against financial stability, reinforcing the tendency of retail and small business lending to be procyclical in nature. Moreover, the UK experience of financial crisis was that losses weren't principally in the wholesale area, rather from retail and commercial lending. The banks that got into difficulty did so by way of classically bad banking practice: lending too much to the wrong people at the wrong price.

What happens elsewhere is important if the UK proceeds down the ring-fence route. For instance, the ICB’s recommendations don’t line up with US separation requirements under Dodd Frank’s Volcker Rule. If countries follow the UK, this will lead to trapped pools of capital and liquidity and reduce the open market for capital finance. This means that in good times, lending capacity will be reduced; in bad times, the ability of banking groups to respond to financial problems will suffer.

Or other countries might not follow the UK lead. As a result, cheaper retail and wholesale services can be passported into the UK from outside without the constraints of a ring-fence. It must always be kept in mind that a ring-fence serves negative purpose if business moves from UK banks to non-UK banks and if the costs and complexity for the very customers it seeks to protect are increased.

Moving on to the proposed increase in loss-absorbing capital, an increase that is far greater than that required by international standard setters. Basel III requires seven per cent, plus a little more in certain circumstances. The UK variant calls for up to ten per cent: banks should hold 17 per cent of loss-absorbing capital, plus up to another three per cent. So at 20 per cent, these recommendations are more or less double the international standard.

Will this make the system more stable? The answer is possibly yes. But again, there is a cost. Some theoretical calculations show that, apparently, it will not cost the industry that much more to fund itself to these levels. Few believe these calculations will pass the test of practice.

I sincerely hope that the investors will be up for the ICB’s proposals. But if they are, I say again that costs will be big. Run up all the associated price tags and the fixed cost of operating a bank will be much higher.  As every businessman and woman knows, you can’t increase the fixed cost of commerce without affecting the price of the goods and services that the business offers. 

On the other hand, if investors aren’t behind the ICB, then the industry will have to deleverage further. That starts to reduce banks' ability to lend. And we all know how difficult and divisive an issue that is already.

Just thinking about putting the ICB’s recommendations into practice isn’t easy. The report’s proposals require clear and careful cost, benefit and impact studies. We have to assess their effects on our economy and we have to appreciate what it is that we really want as a nation.