A review on the implementation of western Ring-Fence Banking
following 2008’s global financial crisis
To what extent will current regulations mitigate future risk
Jack Lloyd Choles
European and International Law LLB (Hons)
University of the West of England
Faculty of Business and Law, Bristol
20th March 2020
1
Acknowledgement:
I would like to thank UWE’s legal faculty as this dissertation would not be
possible without the guidance offered by Dr Mary Young and Nicolas Ryder,
allowing me to bring my ideas together
2
Declaration
3
Abstract
4
Table of contents
1) Introduction………………………………………………………………...6
2) Regulatory battle – American history of Ring-Fence Banking’s birth…9
 2.1: The last century – pre-conditions necessitating RFB
10
 2.2: Wall Street Crash
12
 2.3: Glass Steagall – The provisions of early ring-fencing
14
 2.4: The business of banking” - discretionary departure from Glass-Steagall 18
3) Policy justifications for RFB– minimising risk-prone activity and
government liabilities……………………………………………………..20
4) Anglo-American RFB post-2008………………………………………….24
 4.1: American RFB policy
24
 4.2: Graphical representations of the effectiveness of American RFB
28
 4.3:
Evaluation of the effectiveness of changes
5) Conclusion
5
Introduction
A decade ago, the Independent Commission for Banking (ICB) was purposively established
by HM Treasury to oversee “structural and related non-structural reforms to the UK banking
sector… to promote financial stability and competition,1.” This represented similar regulatory
intent to European changes under Basil III. Meanwhile, America’s financial regulation was
spearheaded by “Dodd-Frank” legislation which sought to undo the deregulation which had
contributed to 2008’s financial crisis. In this manner, western economies government sought
to avoid crises like the bank run on Northern Rock2, the collapse of Lehman’s3 and Europe’s
structural issues from 2010; the events demonstrated the inherent danger of mistrust in
banking In the advent of such an economic peril, it was determined that if banks had been
Ring-fenced, then government would not have been totally responsible for the failure of the
bank as a whole.
Regulatory attempts have since been directed towards a global return to Ring-Fence-Banking
(RFB). This offers a “virtual barrier to segregate a portion of a (bank’s) financial assets from
the rest4. The policy averts government liability for moral hazards lying in risk-prone
investment functions among “universal banks5”. Berger Molyneux and Wilson describe these
as “institutions which combine the lending and payment services of commercial banks with a
wider range of financial services.6” These services are not limited to investment banking and
securities trading across a broad range of derivative, index and ETF markets. As time has
gone on since 2008’s financial crisis, broader support of Ring-Fence Banking (RFB) has
occurred. However, amongst economic incentives, these regulations stand to be undermined.
Independent Commission on Banking (‘ICB’), Final Report: Recommendations (London: ICB, 2011) (‘ICB
Report’), 19. In formulating its recommendations, the ICB was guided by a set of principles including to curb
‘incentives for excessive risk-taking by neutralising subsidies and the unpriced risk of triggering financial
crises’, and to reduce ‘the costs of systemic financial crises’, see page 20.
2
https://www.bbc.co.uk/news/business-41229513
3
Oonagh Mcdonald, Lehman Brothers: A crisis of value, (2016) Manchester University Press
4
Will Kenton, ‘Ring-Fence’, Investopedia https://www.investopedia.com/terms/r/ringfence.asp accessed 1st
Feb
5
A N. Berger, P Molyneux, J. Wilson, The Oxford Handbook of Banking (2010) Oxford University Press,p-171
6
Ibid.
1
6
7
Illustrative analysis of universal and ring-fenced banking
7
In the previous recession, discretion in the implementation of international crisis response
was weakened by broad inability to distinguish between commercial banking, which is vital
to all economic agents, and less necessary investment based functions among universal
banks. It was realised that only by retaining independent capital funds, under a subsidiary
Ring-Fenced body, would it be possible to isolate budgetary support and establish distinct
policy for both the commercial and investment bank. For this reason, the American Federal
Reserve Board, European FSB and UK’s ICB aimed to separate bank functions. Such
banking regulation assures that governments maintain the capacity to target bail-outs to areas
which retain the greatest social benefit to the wider economy. In this manner it is possible to
avoid huge economic consequences which can be attributed to recession with the societal cost
of 2008’s estimated at 75% of annualised GDP8, globally.
9
Chapter 1 primarily examines that universal banking, was adopted in industrializing nations
as a means to, “take advantage of structural incentives,10” and “compensate for structural
impediments to growth11”. My argument follows that economies have evolved beyond early
justifications for deregulation and that increases in leveraging, and decreases in capital
Thom Wetzer, ‘In Two Minds: The Governance of Ring-Fenced Banks’ (2018) Journal of Corporate Law
Studies
8
Brazier, A., (2016), ‘A macroprudential approach to bank capital: Serving the real economy in good times and
bad’, speech available at: https://www.bankofengland.co.uk/speech/2016/a-macroprudential-approach-to-bankcapital-serving-the-real-economy-in-good-times- and-bad
9
Understanding ‘ring-fencing’ and how it could make banking riskier (February 2018) accessible at:
https://www.brookings.edu/research/understanding-ring-fencing-and-how-it-could-make-banking-riskier/
10
Douglas J. Forsyth, Daniel Verdier , Routledge, The Origins of National Financial Systems: Alexander
Gerschenkron Reconsidered, 2003
11
Ibid.
7
8
retention thresholds, among modern banks spell unrealistic budgetary liabilities for states
made responsible for the universal bank as a whole. Therefore, Ring-Fence Banking (RFB)
emerged in direct response to The Great Depression of 1929 under Glass-Steagall12. This
historical outlook is important because evaluating the effectiveness of today’s RFB must
begin with the strength and permanence of prior regulation. Notably, if Glass-Steagall’s
stipulations were considered across global policy, there may not have been a need for the reintroduction of RFB measures. However, this was not the case. De-regulation culminates in
“GLBA” which contributed significantly to 2008’s recession by failing to mitigate ‘too big to
fail’ and a ballooning risk13.
Chapter 3 continues with an analysis of the effectiveness of modern “Dodd-Frank” in light of
Glass-Steagall and the regulatory enforcement which preceded it. This leads to RFB in the
UK which has guaranteed economic security to an extent that deposit protection amongst
consumer banks has been secured by the FCSC at £85,000. It is now widely recognised that
the UK has implemented more stringent reforms than its western counterparts which offers
valuable insight to the effectiveness of RFB as a whole. As a final point, I will summarise
Basil III’s EU enforcement considering that the reforms here have been less restrictive upon
banks. As such, the comparison offers insight to the commercial considerations behind
banking regulation.
2) Regulatory battle – An American history of Ring-Fence Banking’s birth
America offers optimal critical evaluation regarding the ongoing volte-face between ‘laissezfaire’ banking and a more regulated approach offered by ring-fencing. It’s history of policy
conflict identifies the difficulty in upholding incentives for banking institutions to focus purely
on commercial banking and a lesson of how deregulation can contribute to recession,
considering events in 192914. Moreover, policy justifications can be ascertained from the birth
of RFB here, given its introduction under Glass Steagall15. This chapter concludes on the
12
US Banking Act (1933) c. 89, 48 Stat. 162.
Clayton D. Peoples, The Undermining of American Democracy: How Campaign Contributions Corrupt Our
System and Harm Us All (2020) Routledge, p - 122
14
Simon Johnson, James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown,
(2011) Random House, p - 34
15
US Banking Act (1933) c.89, 48 Stat. 162
13
9
ceaseless, selfish conflict between regulators, policy-makers and banks whereby the promotion
of individual, institutional interests progressively allowed nascent RFB policy to be
undermined. Unless RFB legislation is made permanent, system-wide deregulation will,
inevitably, occur which was evidenced by the “Grahamme Leach Bliley Act” (“GLBA”16). The
act facilitated 2008’s recession and through a return to investment banking in universal banks,
once more setting the stage for the 2008’s recession.
2.1: The last century – pre-conditions necessitating RFB
Arguably, the battle with deregulation in global banking policy dates back to America, 1864
with congressional legislation stipulating that banks retain, “all such incidental powers as shall
be necessary to carry on the business of banking17.” This lays the foundation for my essay with
America acting as policy birthplace for RFB in an attempt to counter-act greed incentives
which will typically emerge in the absence of ring-fencing of vital functions. Moreover, policy
freedom was bolstered in 191418 as WW1 created an opportunity for western intervention upon
external legal and economic regimes. This liberty was soon applied to foreign banks. In this
sense, war bolstered an unprecedented international depositor base which created the first
significant change to traditional, small-scale community banking. Furthermore, the expansion
went on to endanger sound banking practice from the 1920’s. This aberration was also
cemented by 1919’s Edge Act19. The statute gave legislative approval to federally chartered
organisations for direct involvement with financial policy-making beyond the US – American
banks rapidly adopted free reign to increase global depositor bases. As a consequence,
investment centred activities hiked banking profits by the 1920s, stepping away from respected
banking principles20. This change dramatically increased depositor bases (+5% p/a from 1921192921) which provided the necessary capital for creative expansion.
16
Financial Services Modernisation Act (1999) Pub.L. 106–102, 113 Stat. 1338
(1864) 12 USC §24(7)
18
Youseff Cassis, The Oxford Handbook of Banking and Financial History, 2010, OUP, p8
19
Federal Reserve Act (1919) ch. 6, 38 Stat. 251
20
Capie, F.; Fischer, S., Goodhart, C. and Schnadt, N. (eds), The future of
central banking: the tercentenary symposium of the Bank of England, (1994) Cambridge, UK :
Cambridge University Press, p - 19
21
Richard H Timberlake, ‘Money in the 1920s and 1930s’, Foundation for Financial Education, April 1st 1999
17
10
Come the 1920’s, development in the extent of investment activities undertaken by commercial
banks had eliminated genuine economic competition, leaving only regulatory authorities
powerful enough to influence banking practice. Banks grew capable of displacing traditional
stock exchanges through direct involvement in investment advisory services22. This included
trade in securities, investments, public offerings of securities, real estate mortgages, and
consumer credit. These new activities meant that, private investors, households and businesses
undertook “heavy debt burdens and risky investments that proved to be unviable when the U.S.
economy entered a sharp recession in the summer of 192923”. It may be argued that these
speculative ventures were undertaken by banks at the expense of trusted retail deposit-taking24.
This demonstrated a turn from time-tested methods of capital generation in pursuit of profit. In
essence, banks abused absent regulation and their own trusted reputation to achieve
stratospheric growth. This perspective is furthered by Walcott’s view that the commercial
banks of old, such as Kuhn Loeb and J.P Morgan, could not have financed such unprecedented
growth without a turn to securities, stating “their growth has been phenomenal, coincident with
the growth of the security business25.” This offers central insight in to the inevitability of banks
reverting to profit-seeking behaviour in the absence of limiting regulation, or a ring-fenced
approach.
It is widely argued that without the creation of extensive credit and distribution facilities among
banks, the extent of over-investment which preceded the Wall Street Crash would not have
been possible26. This change was significant because it mirrors the pre-conditions of 2008’s
recession. Perhaps if regulation had persisted then American born recessions may not have
been as baring on the global economy. With this considered, banks are “crucial for economic
growth27.” Therefore, the notion that they could have been, or can be, expected to limit their
own financial development, through increasing revenues, is simply unrealistic. American
22
Kenneth D Garbade, Birth of a Market: The U.S. Treasury Securities Market from the Great War to the
Depression, (2012) Massachusetts Institute of Technology, p - 187
23
Arthur E. Wilmarth Jr, ‘Did Univ Did Universal Banks Play a Significant Role in the U.S. E y a Significant
Role in the U.S. Economy's Boom-and-Bust Cycle of 1921-33? A Preliminary Assessment’ (2005) George
Washington Law school, accessible
https://scholarship.law.gwu.edu/cgi/viewcontent.cgi?article=2164&context=faculty_publications
24
International Monetary Fund, Current Developments in Monetary and Financial Law (volume 4), (2007)
International Monetary Fund Publications, p-565
25
Senator Walcott, 75 Cong. Rec. 9904, 9906 (1932)
26
Current Developments in Monetary and Financial Law – 4, International Monetary Fund, p-540
27
Anjan V. Thakor, The Purpose of Banking: Transforming Banking for Stability and Economic Growth (2019)
Oxford University Press
11
banks had been permitted to focus on capital generation at the expense of their prior customer
dedication in commercial banking.
Therefore, an argument arises that financial regulation is key to limiting the moral hazards
undertaken by banks considering that bank liberalisation can be seen to encourage pursuits
aligned solely to generating profit. This, necessary comes at the expense of economically
desirable functions. Regulation was, however, insufficient. Moreover, the McFadden Act
192628 also failed as the sole a priori attempt to regulate bank abuses of scale by regulating
individual branch function on an inter-state level. The act had intended to prevent national
commercial banks from acting in contradiction to societal interest. However, federal regulatory
powers had not yet been granted which allowed banks to continue to abuse their trusted position
in investment-centric policy-making.29” This identifies how a stronger model is required which
brewed ideas of separating universal banking functions under a ring-fence. All in all, these
factors amount to the notion that regulation had proved to be insufficient but that some form
of limitation to corporate governance would likely provide a better economic alternative than
total freedom for financial institutions to pursue profit at the cost of financial security.
2.2: Wall Street crash
From 1929 to 1932, the world was plunged into The Great Recession, where disinvestment
occurred to unprecedented levels, as economies lost confidence in the recommendations of
banks and their securities affiliates. The combined total of all common stocks listed on the New
York Stock Exchange fell by nearly 85 percent, from $82.1 billion to $12.7 billion,30 or a mere
88% of annualised GDP31. Likewise in 2008’s financial crisis, the market value of shares held
in NYSE companies fell to 82% of GDP32. These figures identify the extensive loss of
investment which often accompanies recession. They also identify a potential link between
deregulation in both instances. In 2004, as a benchmark, the average investment holdings
across the UK, US and France totalled a huge 186% of GDP33. The comparison in investment
28
McFadden Act
Current Developments in Monetary and Financial Law – 4, International Monetary Fund, p-565
30
Barrie A. Wigmore, The Crash and Its Aftermath: A History of the Securities Markets in the United States,
1929–1933 (1985) Greenwood Press p 640–43
31
David Murillo, From Walmart to Al Qaeda: An Interdisciplinary Approach to Globalization, s4.3.2
32
Ibid.
33
Ibid. s4.3.2
29
12
as a proportion of GDP identifies the full extent to which a fall in investment may limit
economic confidence during recession.
Policymakers now widely accepted that the extended reach of banks and newfound domination
in securities trading exacerbated the extent to which they, and their clients, were disaffected by
the crash. This was, however a problem rooted in their own optimistic inaction. Under
“relaxation of legal rules governing bank activities, banks had greatly expanded their financing
of business firms and consumers through five major channels—loans on securities, securities
investments, public offerings of securities, real estate mortgages, and consumer credit.34”
Critics of the extended services offered by “department store banking35” approach, not limited
to Senator Glass, suggested that corrupted securities and investment advise by commercial
banks promoted “stock-gambling” and “over-investment in securities of all kinds36”. By
implementing such detrimental policy change, banks took a back-step from their established
commercial functions which “diverted from original purpose37” into risk-prone investment
activity. Service (was) “devoted to speculation and international high finance38”. This overt
pursuit of profit incentive was a re-occurring motive leading to both recessions. However, at
this stage, it was determined that regulators had an obligation to enforce sound practices
through legislation in order to return trust to banks. The first solution to this was presented in
1933, and Ring Fence Banking was born, through the Glass-Steagall Act39.
2.3: Glass Steagall – The provisions of early ring-fencing
Ring-Fence Banking policy was crafted under direction from the newly established Federal
Open Market Committee (FOMC) in 1933 with the passing of Glass-Steagall40. Amongst
evident change to financial policymaking, it remained consistent that the board continued to be
comprised of all 12 representing governors of each Federal Reserve Bank. However, FOMC
now retained binding power to regulate American banks in the first significant attempt to
Arthur E. Wilmarth Jr, ‘Did Universal Banks Play a Significant Role in the U.S. Economy's Boom-and-Bust
Cycle of 1921-33? A Preliminary Assessment’ (2005) George Washington University Law School
35
Maury Klein, The Genesis of Industrial America, 1870–1920 (2007) Cambridge University Press, p127
36
77 Cong Rec. (1933) Re Senator Glass, 3725-26
37
77 Cong Rec. (1933) Re Henry Steagall, 3835
38
Ibid.
39
US Banking Act (1933) c.89, 48 Stat. 162
40
Ibid.
34
13
restore confidence in the banking system. In keeping with this drive towards the restoration of
confidence, regulation was also introduced to reform the conduct of those underwriting
securities in the Securities Act (1933), Securities Exchange Act (1934), Public Utility Holding
Companies Act (1935) and the Investment-Companies Act (1940). Although, I will not explore
these acts in detail given my focus on Ring-Fence Banking. Notwithstanding, these acts
demonstrated, to broad opposition from bankers, economists and even the Chair of the Federal
Reserve Board41, the first acceptance of a regulatory failure to prevent financial crisis. Broadly,
Glass-Steagall act can be divided into two equally significant sections; 1) Separation of
commercial and investment banking (sections 5, 16, 20, 21, 32) and; 2) Restrictions upon the
use of banks for speculation (sections 3, 7, 9, 11)42.
Under the segregation of commercial and investment banks; regulators imposed a fixed ring
fence upon the distinct activities performed by distinct banking institutions. Under section 7,
deposit-taking amongst firms already involved with the exchange of securities was deemed
unlawful practice from one year past the Banking Act’s accession into law (33 June 1933)43.
This demonstrates the clear, hurried attempt to address universal banks, identifying significant
responsibilities for the recession, incorporating a range of influential findings, including the
report issued by the National Industrial Conference Board44. The act initiated a specific focus
upon regulating the future conduct of commercial banks in an attempt to assure trust in their
essential deposit-taking functions. Thus the underwriting of securities, the active trading in
bonds under a common fund and advisory of customers, with regard to investments, by
commercial banks became prohibited actions45. Consequently, even the sharing of mutual
directories between banks and their securities affiliates was rendered unlawful46. This change
assured that the bodies could operate distinctly and that shaken confidence in investment banks
did not carry to savings institutions. The changes which were implemented implied a federal
obligation to correct the market failure which had occurred in banking and investment markets.
Fundamentally, in a simpler era of banking, regulators implemented all possible such necessary
measures as to prevent the policies of the 1920s from repeating.
41
Eugene Meyer, Federal Reserve Bulletin (April 1932) Federal Reserve Board, p206-222
Howard H Preston, ‘The Banking Act of 1933,’ The American Economic Review, Vol. 23, No. 4 (1933) p-585607
43
US Banking Act (1933) c.89, 48 Stat. 162 – s21
44
The Banking Situation in the United States (1932); Availability of Bank Credit (1932)
45
US Banking Act (1933) c.89, 48 Stat. 162 – s5,16,20
46
Ibid. s-32
42
14
Similarly it is noteworthy that, seeking to guarantee that credit was allocated to sound ventures,
and not merely those which were optimally profitable, the act defeated purely speculative bank
investment. It accomplished this through instigating specific responsibility for Federal Reserve
Banks (FRB) to stay informed regarding the nature of credit uses whether for genuine business,
real estate, commodities or speculation. In doing so, the act also gave powers of suspension
where undue uses of capital were observed47. Secondly, distinct regional loan to capital ratios
became an additional regulatory power of regional FRBs; they were able to control further
increases in loans conducted by banks which prevented rediscounting (see definition48)
privileges being abused49. Section 7 was key because it limited the government obligation
inherited from undue use of surplus reserve capital for bank profit without the assumption of
risk50. The FRB was equally granted increased control over support loans to member banks
with the loan period being extended from a maximum of fifteen to ninety days with the ability
to immediately recall if non-compliance with the aforementioned conditions was observed51.
Finally, section 11 fused these two broad purposes of the 1933 Banking Act by preventing
banks from acting as loan broking agents on behalf of non-banking organisations52. In
summary, the act culminates in specific powers for the FRB and effective regulation to policy
risk-prone investment banking decisions. Under perfect conditions, these being continually
observed could have mitigated the recessions of recent years considering their origins in
unsound investment. However, Glass-Steagall did not remain enforced and reform undid many
of the idealistic principles as I will explore.
2.4: “The business of banking” - discretionary departure from Glass-Steagall
Banking regulation progressively evolved in favour of economic interests under intense
pressure from capitalism itself. Going forth from the Banking Holding Company Act, banks
gained selective permission to conduct non- banking business53, fuelling expansion. This
contributed to the ‘Golden Age of Finance’54 which eventually resulted in total abolition of
47
Ibid. s-3
James Ken, ‘Rediscount’ (2020) accessible at: https://www.investopedia.com/terms/r/rediscount.asp
49
US Banking Act (1933) c.89, 48 Stat. 162, s-7
50
Ibid. s7
51
Ibid. s9
52
Ibid. s11
53
Bank Holding Company Act (1956) P. Law, 84-511, 70 Stat. 133
54
Michael John Webber, The Golden Age Illusion: Rethinking Postwar Capitalism (1996) The Guildford Press,
p - 28-40
48
15
Glass-Steagall. Although other cases had emerged55, the first significant departure56 from the
principles of segregated investment and consumer banking was witnessed in Securities
Industries Association v Clarke (1990)57. In this instance, the US Appeals Court re-interpreted
what constituted, “incidental powers as shall be necessary to conduct the business of
banking.58” Furthermore, the case enabled banks to perform any such activities which the
Comptroller of the Currency deemed appropriate to sustaining banking interests.
Consequently, the court found that the creation of securities linked to mortgages under the
banks customer base could be considered as “the business of banking” rather than the restricted
practice of “business of dealing in securities and stock” banned under s24(7). In essence, this
was the first opportunity for banks to amalgamate securities based functions under a
commercial bank. This departed from Glass-Steagall’s stringent separation of commercial and
investment banking.
Changes to regulatory interpretation were cemented with further elaboration by America’s
Supreme Court, with binding effect on lower courts, in “VALIC59.” The case continued with
an open critique of the five specific banking activities which banks had been limited to by
s24(7). These fixed actions which commercial banks were now restricted to were; discounting
and negotiating promissory notes; receiving deposits; buying and selling exchange, coin, and
bullion; loaning money on personal security; issuing and circulating notes. It had been
determined that this fixed group of functions lacked the comprehensiveness that banks required
in order to competitively conduct their business since Clarke. For this reason, judges referred
to the fact that the burden of interpretation in such cases rested with the Comptroller of the
Currency. The effect of this was to bolstered discretion over constructionism, warranting an
expansion in commercial banking functions in securities, so long as these “kept within
reasonable bounds.60” However, these limited conditions were insufficient to deter banks from
the pursuit of profit. In this sense, scope was provided for banks to explore options beyond the
traditional realms of commercial banking once more.
55
A.G. Becker Inc. v. Board of Governors, Etc., 519 F. Supp. 602 (D.D.C. 1981)
Gary Rice and Steven Delott, ‘Travelers Group, Citicorp And The Federal Reserve,’ Journal of International
Banking and Financial Law (1998) 5 JIBFL 174
57
Securities Industries Association v Clarke, 885 F2d 1034 (2d Cir), cert denied, 493 US 1070 (1990).
58
12 USC §24(7) 1864
59
Nationsbank of North Carolina v Variable Annuity Life Insurance Co, 513 US 251 (1995).
60
Nationsbank of North Carolina v Variable Annuity Life Insurance Co, 513 US at 258-259 (1995) n2.
56
16
As a result, the Comptroller of the Currency was given the tools to establish an adapted
framework for identifying banking activities analogous to “the business of banking.” Broadly,
these may be summarised as a three stage examination: “(i) whether an activity is functionally
equivalent to, or a logical outgrowth of, a recognized bank power; (ii) whether the activity
benefits bank customers and/or is convenient or useful to banks; and (iii) whether the activity
presents risks of a type similar to those already assumed by banks61.” This test looked towards
discretion, arguing that it would more responsive to the rapid developments in banking which
required altogether different policies to Glass-Steagall.62 In this manner, American banks
would be able to remain competitive in an increasingly globalised banking world with financial
deregulation across the water proving hugely successful for Britain’s financial institutions with
Lawson’s ‘Big Bang’ in London since 1986. It may be inferred that, once more, America was
incentivised by a profit motive with the detriment of financial deregulation a very distant
memory by this stage. It is equally indicative of international deregulation which was a central
characteristic foreshadowing 1929’s recession as mentioned on page 13.
The Comptroller of the Currency had already granted national banks the freedom to create
operating subsidiaries in 1965 to provide scope for future amendment to banking regulation
under changes of circumstance. Therefore, following the aforementioned changes in “VALIC”,
the Comptroller promulgated an increased range of banking functions through subsidiaries.
Ergo, it was determined that the 5 limitations which had broadly dictated and restricted the
banking activities of national commercial banks no longer applied in the instance of bank
subsidiaries. The courts were unlikely to oppose this change given that deference to the
Comptroller’s decisions had been given early precedent in 1971’s Investment Company
Institute v Camp63. The same notion was later paraphrased and reiterated in “VALIC” which
stated that, “the Comptroller of the Currency is charged with the enforcement of banking laws
to an extent that warrants the invocation of this principle with respect to his deliberative
conclusions as the meaning of these laws.64” This provided an effective loophole to undermine
the restrictions which had once governed American banks. The result was rapid jurisprudential
volte-face which would soon pave the way for a change in the conduct of banks aswell as the
policy pursuit of regulators. As such, de-regulation became a fashion.
61
Williams & Jacobsen, “The Business of Banking: Looking to the Future” 50 Bus Law 783, 798 (1995).
Williams & Gillespie, “The Business of Banking: Looking to the Future – Part II” 52 Bus Law 1279 (1997)
63
Investment Company Institute v Camp 401 US 617, 626, 627 (1971)
64
Nationsbank of North Carolina v Variable Annuity Life Insurance Co (1995) 513 US at 256–257
62
17
These changes soon culminated in mergers, operational changes to the subsidiaries of national
banks and, eventually, legislated deregulation. Long-standing American institution Zions First
National Bank applied the following year for license to operate mortgage bond underwriting
services which was awarded by the Comptroller. This demonstrated an even greater application
of discretion by the Comptroller in direct contradiction to Glass-Steagall’s explicit separation
of commercial banking and the exchange of securities. Even more impactful to the established
regulation was the $75billion merger of Travelers and Citycorp65 which demonstrated the first
overt incorporation of commercial banking to an extended range of functions. The merger was
quickly approved, and Citygroup created, following rapid approval by the Federal Reserve
Board. The acceptance was once again reminiscent of self-interested competition as it
presented benefit to even the Federal Reserve Board, forever seeking to expand upon the
regulatory powers vested upon it by law. In this sense, deregulation became equally desirable
to traditionally opposing interests amongst bankers, economists and the FRB alike. It is
arguable that “Citigroup typifies so many abuses in the banking industry over the last half
century66,” prudent Wall Street analyst Mike Mayo debated whilst equally suggesting it was
this very ignorance of legislation which set pace for the upcoming Wall Street Crash. In any
case, it is evident that courts, regulators and the FRB had hugely facilitated the process, seeking
to further their own interests, allowing Glass-Steagall’s banking restrictions to be undermined.
Gramm-Leach-Bliley Act – de-regulating American banks
The regulatory pressure in aversion to bank ring-fencing was underscored by Congressional
support for the changes which had already been enacted in November 1999. This took shape
in the “Gramm-Leach Bliley Act67” (GLBA) which greeted the new decade with, “a prudential
framework for the affiliation of banks, securities firms, insurance companies and other
financial services providers68”. In practice, the act legislates extended ‘umbrella’ powers for
the Federal Reserve Board to regulate the conduct of all financial services holding companies.
Therefore, the act is indicative of the pressure which had caused Congressional ignorance and
promoted fused activities between commercial banking, securities advise and direct
Mitchell Martin, International Herald Tribune, ‘Citicorp and Travelers Plan to Merge in Record $70 Billion
Deal : A New No. 1:Financial Giants Unite’, (April 7th 1998), New York Times, accessible at:
https://www.nytimes.com/1998/04/07/news/citicorp-and-travelers-plan-to-merge-in-record-70-billion-deal-anew-no.html
66
Exile on Wall Street: One Analyst's Fight to Save the Big Banks from Themselves
67
Financial Services Modernization Act (1999) Pub. L. 106–102, 113 Stat. 1338
68
Gramm-Leach-Bliley Act: Conference Report (to Accompany S. 900) (1999) U.S Congress
65
18
investment. It is equally evident of the departure from legislative controls over the conduct of
banks – the act heralded a return to universal banking.
The Financial Services Modernisation Act (GLBA) details the explicit repeal of GlassSteagall69. This identifies diversion in from restrictions on banking conduct, favouring a more
laissez-faire approach. Regulators sought to accommodate a power shift to the discretion of the
Federal Reserve Board, offering banks greater flexibility than “Glass-Steagall” from the outset.
A hugely significant amendment to the Bank Holding Act of 1956,70 permitted banks to engage
in the absolute discretionary range of securities, underwriting and investment based activity
that the FRB deemed acceptable. The conditions of acceptance for new commercial banking
activity under s103 “GLBA” were generally limited to only 2 factors which considered the
action; “(A) to be financial in nature or incidental to financial activity; or (B) complementary
to a financial activity and does not pose a substantial risk to the safety or soundness of
depository institutions or the financial system generally71.” Although these conditions infer
brief attentiveness to the huge baring of moral hazards in banking policy upon society, the act
effectively adopted free reign for commercial banks to undertake new activities at the expense
of securing bygone depositor security. As was expected by provisions regarding a purposive
use of discretion considering the act’s intent72, the deregulation of banks contributed to a
growth investment which had already been facilitated in aforementioned case law and the
discretion of the Comptroller of the Currency/ FRB. Such conditions were nostalgic of the
freedom which banks had assumed leading up to 1933’s financial crisis and would eventually
lead to the dot-com bubble burst, and worse still, the Wall Street Crash.
Policy justifications for RFB – minimising risk-prone activity and government liabilities
America’s volte-face in RFB policy, academic insight and the recent evidence from global
recessions form a rounded authority which provides that where banking regulation fails,
economies do too73. It may surmised that regulatory failure often resides in the overt
69
Financial Services Modernization Act (1999) Pub. L. 106–102, 113 Stat. 1338, s101(a)
Bank Holding Company Act (1956) Pub. L. 84-511, 70 Stat. 133, s4
71
Financial Services Modernization Act (1999) Pub. L. 106–102, 113 Stat. 1338, s103
72
Ibid. s103 (3)
73
Howard J Sherman , The Roller Coaster Economy: Financial Crisis, Great Recession and the Public Option,
(2015) Routledge, p- 180
70
19
concentration which western corporate governance places upon shareholder value rather than
social stability74. This fact has remained consistent across 21st Century economic ‘booms’
and the crises which have adhered closely to them. Moreover, Economists have argued that,
where shareholder interests take primacy, banks will take decisions solely to maximise profit.
This comes without regard to the value of commercial banking functions75. Such tendencies
emphasise the importance of banking regulation being capable of withstanding an inevitable
advocacy in favour of deregulation which permeates banking from all angles (addressed in
the previous chapter.) Previously, regulators failed at preventing banking operations from
sole focus on monetary incentive. Considering this, regulation going forth must permanently
assure that banks can not shy away from social responsibilities by selfishly dedicating to the
most profitable activities possible. Leading banks must be made to pursue objectives beyond
institutional gain and advocate for greater society or they will consciously bare cost upon taxpayers76.
Banking functions are entirely unique in their socio-economic purpose which is why
governments seek to protect them. First and foremost, they offer an intermediary service for
direct monetary transfer in both payment and receipt, demonstrating a hugely efficient
method of capital allocation77. They are equally responsible for savings which are a prerequisite to the levels of personal stability required to guarantee future among economic
agents or the populations of western society. Without this stability, the capability for
consumers to commit to repeat or future payments is diminished. More specifically, banking
institutions are the sole supplier who are able to offer a platform for liquidity, allowing
maturity and credit transformation78 across finance. Evidently, these are all socioeconomically desirable functions which justify why governments proactively seek to avoid
the failure of commercial banks during recessions.
P Davies, ‘Shareholders in the United Kingdom’ in R Thomas and J Hill (eds), Research Handbook on
Shareholder Power (2015) Edward Elgar
75
JR Macey, ‘An Economic Analysis of the Various Rationales of Making Shareholders the Exclusive
Beneficiaries of Corporate Fiduciary Duties’ (1992) Stetson Law Review Vol. 21, 23-44
76
House of Commons, Exporting out of recession: third report of session 2009-10, Volume 2, EV 18, Q158, as
per Lord Jones of Birmingham
77
Thom Wetzer, ‘In Two Minds: The Governance of Ring-Fenced Banks’ (2018) Journal of Corporate Law
Studies, p- 5
78
W. W. Rostow, The Stages of Economic Growth: A Non-Communist Manifesto, (1990) Third Edition,
Cambridge University Press, ch.5, p - 59
74
20
However, structural fragilities are often exposed during economic downturns. This has left
banks prone to runs in recent years79 which give rise to the potential for significant
government liabilities. Mitigating these which should be at the heart of financial policymaking. During recessions, markets experience exponential decreases in the value of
investments, particularly in the case of leveraged options created by banks or their security
affiliates. Consequently universal banks, whose extensive capital allocation to risk-prone
sectors is high in the absence of regulation, are likely to experience serious liquidity and
solvency dangers. This creates the beginning of liabilities because, due to the aforementioned
reasons, government bodies have no choice but to bail-out the bank as a whole. Worse still,
these solvency problems are not isolated to financial institutions due to the aforementioned
reliance on banks across industry. This often means that liquidity issues can be experienced
system wide as contagion which disaffects the financial health of other industries and
business80. Going further, insolvency across businesses often follows recessions which is how
wider economic depressions occur81. This regressive process explains how a system wide
financial crisis may evolve - Widely distributed losses are hugely exacerbated by the failure
of Systematically Important Banks (SIB)82. It is this ‘credit crunch’ which creates long-term
liquidity issues for banks and the wider economy, which rely upon them to sustain
consumption as a vital component of demand, thus deepening economic crises83. Therefore,
policy should focus on protecting commercial banking functions. In any case, reliance upon
bail-outs for the universal bank exacerbates the moral hazards undertaken by banks84.
Furthermore, regulations must also proactively avoid responsibility for the irresponsible
management of funds through investment banking. This is where RFB is emerges as a
successful method of limiting national exposure to the failure of SIBs.
D Diamond and P Dybvig, ‘Bank Runs, Deposit Insurance, and Liquidity’ (1983) Journal of Political
Economy Vol. 91, Issue 3, 401-419; HS Shin, ‘Reflections on Northern Rock: The Bank Run that Heralded the
Global Financial Crisis’ (2009) Journal of Economic Perspectives Vol. 23, No. 1, 101-119
80
S Benoit, J-E Colliard, C Hurlin and C Perignon, ‘Where the Risks Lie: A Survey on Systemic Risk’ (2015)
HEC Paris Research Paper No. FIN-2015-1088.
81
J Armour, ‘Making Bank Resolution Credible’ in N Moloney, E Ferran and J Payne (eds), The Oxford
Handbook of Financial Regulation (2015) Oxford University Press
82
T Adrian and HS Shin, ‘Liquidity and Leverage’ (2010) Journal of Financial Intermediation Vol. 19, No. 3,
418-437
83
C James, ‘The Losses Realised in Bank Failures’ (1991) Journal of Finance Vol. 46, No. 4, 1223-1242; MB
Slovin, ME Sushka and JA Polonchek, ‘The Value of Bank Durability: Borrowers as Bank Stakeholders’ (1993)
Journal of Finance Vol. 48, No. 1, 247-266; AB Ashcraft, ‘Are Banks Really Special? New Evidence from the
FDIC-Induced Failure of Healthy Banks’ (2005) American Economic Review Vol. 95, No. 5, 1712-1730.
84
Heidi Mandanis Schooner, Michael W. Taylor, Global Bank Regulation: Principles and Policies, (2009)
Academic Press, p -64
79
21
To elaborate on ‘moral hazards’ which purvey universal banking, increased risk-prone
activity is often undertaken under the notion of being ‘too big to fail’. Authorities commonly
elect to support a failing SIB with a bailout of sorts, rather than running the risks insolvency
might entail85. When faced with declines in the economic climate, as in 2008’s Depression,
they prevent runs on banks and short term creditors by insuring deposits86. This could be
bearable if isolated to commercial banking. However, responsibility for the concurrent failure
of investment banking functions of universal banks spells unrealistic liabilities. This is due to
an intense concentration of bank capital allocated to investment and securities markets. In
2008, Anglo-American Banks relied upon support for the entire bank which demonstrates a
failure in the universal banking regime which must be avoided by the present and future
implementation of RFB. Furthermore, a general rule may be established that reliance on
being ‘too big to fail,’ or being reassured in the provision of government support for riskier
functions, negatively interacts with taxpayer liabilities when banking policies surround
shareholder primacy87. It should be an expectation that banks will adapt to regulation and
implement policy change to adopt greater systemic risk in order to maximise the use of free
insurance. This translates to the risk-prone ventures, which I have previously explored,
reliance upon cheaper and more unstable funding and an exponential growth in the use of
leverage88 in their capital structure. Ring-fencing must therefore target these areas and set
strict limits on the extent of leverage undertaken and their responsibility for each banking
function in order to avoid moral hazards.
Going further still, RFB should allow governments to control funding and implement
discretional support outside of areas where banks have been reckless in their ventures. This is
often difficult considering that banks proactively seek to increase the likelihood of state
support through complicated resolutions in order to increase their systemic importance
Thom Wetzer, ‘In Two Minds: The Governance of Ring-Fenced Banks’ (2018) Journal of Corporate Law
Studies, p - 6
86
Jeffrey Friedman, What Caused the Financial Crisis (2011) University of Pennsylvania Press, p- 60
87
J Armour and JN Gordon, ‘Systemic Harms and Shareholder Value’ (2014) Journal of Legal Analysis Vol. 6,
No. 1, 35-85; M Roe, ‘Structural Corporate Degradation Due to Too-Big-To-Fail Finance’ (2014) 162
University of Pennsylvania Law Review Vol. 162, 1419-1464; J.E. Fisch, ‘The Mess at Morgan: Risk,
Incentives, and Shareholder Empowerment’ (2015) University of Cincinnati Law Review Vol. 83, No. 3, 651684.
88
AD Morrison, ‘Systemic Risks and the “Too-Big-To-Fail” Problem’ (2011) Oxford Review of Economic
Policy Vol. 27 No. 3; A Admati and M Hellwig, The Bankers’ New Clothes – What’s Wrong with Banking and
What to Do About It (2013) Princeton University Press
85
22
through growth in scale89. Therefore, RFB should attempt to limit the extent which activities
come under one singular capital fund in order to mitigate liability for the institution as a
whole. This prevents banks from becoming ‘too big to fail’. In effect, this primarily means
targeting banking activities which are arbitrary and merely allow an increased scope of
activities90 in order for increased importance. Secondly, regulators must seek to avoid the
capacity for banks to be unnecessarily complicated so that direct bail-outs can be as efficient
and effective as possible91. This averts the scenario which became prevalent in the prior
recession whereby government was made responsible for institutions that were widely
involved with investment alone, simply due to an inability to isolate funding to more essential
areas. Finally, regulation should seek to avoid banks with inter-connected functions beyond
absolute necessity92. This, once more guarantees that funding may be appropriated where it is
needed most and that banks can not cover themselves under the guise of riskier investments
being essential to truly necessary commercial banking.
To conclude, governmental responsibility for bank failures are eventually borne by the
taxpayer through direct financial responsibility for bail-outs in national debt and the
necessary universal credit pay-outs akin to recessions. It is this liability which highlights the
weight of this dissertation and identifies two significant advantages which successfully
enacted RFB policy must provide for government. Ring-fencing must permit; 1) government
to be selective in bail outs and target only the vital commercial banking functions in order to
incentivise banks not to rely upon being ‘too big to fail’93 and; 2) banks to be restricted from
the risk-prone activities which their governance structures tend to undertake94, knowing that
the entirety of their functions are supported by ‘free’ deposit insurance. RFB must, therefore,
E Kane, ‘Incentives for Banking Megamergers: What Motives Might Regulators Infer from Event-study
Evidence?’ (2000) Journal of Money, Credit and Banking Vol. 32 No. 3; VV Acharya, D Anginer and AJ
Warburton, ‘The End of Market Discipline? Investor Expectations of Implicit Government Guarantees’ (2016)
Working Paper.
90
See RW Ferguson, P Hartmann, F Panetta and R Portes, International Financial Stability (CEPR 2007); J
Brewer and J Jagtiani, ‘How Much Did Banks Pay to Become Too-Big-To-Fail and to Become Systemically
Important?’ (2013) Journal of Financial Services Res. Vol. 34.
91
R Herring and J Carmassi, ‘The Corporate Structure of International Financial Conglomerates: Complexity
and Its Implications for Safety and Soundness’ AN Berger, P Molyneux and JOS Wilson (eds), The Oxford
Handbook of Banking (2010) Oxford University Press
92
K Judge, ‘Interbank Discipline’ (2013) 60 UCLA Law Review 1262, 1267
93
University of Michigan, Too Big to Fail?: The Role for Bankruptcy and Antitrust Law in Financial Regulation
Reform, Part 1 (2010) US Government Printing Office
94
E Perotti, L Ratnovski, R Vlahu, ‘Capital Regulation and Tail Risk’ (2011) International Monetary Fund
(working paper) p - 8
89
23
provide the capacity for banks to be made responsible for their successes and failures, rather
than greater society who rely upon them.
4) Anglo-American RFB post-2008
Going forth, this chapter addresses the effectiveness of the global implementation of RFB,
addressing US, UK and European policy in light of; 1) significant impacts of recessions in
these states and; 2) the differences in their policy implementation of RFB. American
regulation sets precedent for the global standard in legislation, with changes implemented
under the “Dodd- Frank” act, attempting to segregate commercial banking from investment
based functions. This intent has been widely mirrored in the UK, but falls short in Europe.
This chapter also address how financial policy boards have been established in each banking
region in order to add ‘teeth’ to discretion so that regulators may respond to changes in
banking practice without stifling economic activity. It will examine their permanence and the
extent to which a discretionary body may retain any permanence at all. Finally, this chapter
explore the specific banking requirements of each area to assess the comprehensiveness of
RFB in all of these regions.
4.1: American RFB policy
In direct response to the financial crisis, the USA fortified RFB policy, heralding reversion in
the international jurisprudence for bank deregulation. Furthermore, regulation directly
addressed calls for ‘stronger standards,’ to protect against “moral hazards presented by
(potentially unlimited, free) deposit insurance95”. Likewise, Obama announced his intention
to bring an end to the concept of ‘too big to fail96’. Consequently, the Restoring American
Financial Stability Act (Bill) 2010 (“RAFSA”) introduced notional discretionary supervisory
bodies to govern banks. “Dodd Frank”97 then cemented draft legislative provisions and set
strict limits on the risk-prone functions which had permeated American banking. Change
came with the realisation amongst known advocates of deregulation, including Citygroup’s
95
J Friedman, W Kraus, Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation (2011)
University of Pennsylvania Press, p114
96
The White House, President Obama Calls for New Restrictions on Size and Scope of Financial Institutions to
Rein in Excesses and Protect Taxpayers (2010) Office of the Press Secretary
97
Dodd–Frank Wall Street Reform and Consumer Protection Act (2010) Pub. L 111-203
24
Chairman98, that Glass-Steagall had successfully mitigated financial crises for over half a
century. Therefore, acceptance of deregulation’s failure had inspired legislative reform of
corporate governance. This paved the way for a return to the segregation of retail banking,
requiring that economically vital activity was kept in a ring-fence. However critics, on both
sides, have since argued for both stricter reforms and a return to deregulation. Such conflict,
among Trump’s partial amendments to banking regulation99, bring the overall success of the
act into question. This calls for a summary of American RFB, examining what remains of
Dodd-Frank. Moreover, American regulation’s effectiveness at shielding retail banking from
the risk-prone investment practices which contributed to preceding recessions, may now be
brought in to question.
Originally, Dodd-Frank established specific limitations on retail banking institutions
engaging in proprietary or financial trading, limiting government responsibility for failures
due to mismanagement. This is conducted through under the ‘Volcker-Rule’ or s619 of
Dodd-Frank100. The act makes formal amendments to the Bank Holding Act of 1956101 which
state transparent restrictions to banking activities being conducted under one holding
company and requiring subsidiaries for separate functions. Specifically, the amendments
provide that banks may not engage in proprietary trading102, nor acquire equities, partnership
or ownership interests in hedge funds or investments103. This signifies a return to bank
regulation with limitations on the profit seeking nature of American corporate governance.
RASFA, or the “Dodd-Bill”, introduced notional supervisory bodies in order to provide
‘teeth’ to the implementation of banking regulation. This aim was eventually enacted by the
Dodd-Frank Act which begun by dissolving the Office of Thrift Supervision, concurrently
bolstering additional supervisory powers in the Federal Deposit Insurance Cooperation
(“FDIC”). The FDIC has allowed deposit insurance which guarantees $250,000 of protection
to customers of member banks. Equally, additional powers conferred in the newly formed
98
S Denning, "Rethinking Capitalism: Sandy Weill Says Bring Back Glass-Steagall" (2012) Forbes, Quoting
interview on CNBC's Squawk-Box
99
Jacob Pramuk, Trump signs the biggest rollback of bank rules since the financial crisis, CNBC accessible at:
https://www.cnbc.com/2018/05/24/trump-signs-bank-bill-rolling-back-some-dodd-frank-regulations.html access
date: 11th January 2020
100
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) P.Law 111- 203, 124 STAT. 1620,
s619
101
Bank Holding Company Act (1956) P. Law, 84-511, 70 Stat. 133, s13
102
Ibid. s13(1)(a)
103
Ibid. s13(1)(b)
25
Consumer Financial Protection Bureau aimed at creating transparency and fairness in
mortgages, credit cards and other financial products104. These two institutions seek to
implement RFB reform from the consumer end and ascertain protections for deposits and
retail banking functions. Overall, the bodies provide an impression of greater security for
bank customers.
Furthermore, in order to address the banking or supply side issues in finance, Dodd Frank
created the Financial Stability Oversight Council (“FSOC”)105 in order to provide additional
scrutiny to non-banking affiliates of banks. FSOC was established with clear goals of
maintaining order in the banking sector and retains specific powers to regulate “nature, scope,
size, scale, concentration, interconnectedness, or mix of the activities106” performed by
financial firms linked to a bank holding company. These competences indicate the extensive
controls which Dodd-Frank has retained across financial institutions. While enacting these
powers, the FSOC may consider; the leverage of relevant firms107, the nature and extent of
off-balance sheet exposures108 and the extent and nature of the transactions and relationships
with the bank-holding company109. The relevant information for such decisions rests with the
insider Office of Financial Research (“OFC”) which sits within the treasury. Considering its
supporting role, the institution equally helps to “promote financial stability” and shine a light
in hidden corners to expose threats to the financial system110. These institutions do indicate,
to a large extent, that American regulation has successfully taken steps in order to create a
permanent ring-fenced system. Their inter-relationship provides an enforcement web which
undermines the ability for abuses of the system to be lead by one institution in a similar
fashion to that of the Comptroller of the currency and Glass Steagall. With this said, it must
be considered that there is still an element of discretion as to the extent of regulation and
which activities are considered an economic threat. It is also noteworthy this discretion may
Federal Register, ‘Consumer Financial Protection Bureau’ (2020) Daily Journal of the United States
Government, National Archive, accessible at: https://www.federalregister.gov/agencies/consumer-financialprotection-bureau access date: 21st January 2020
105
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) P.Law 111- 203, 124 STAT. 1398,
s111
106
Ibid. s113(a)(1)
107
Ibid. s113(2)(A)
108
Ibid. s113(2)(B)
109
Ibid. s113(2)(C)
110
Office for Financial Research, ‘About the OFR’ (2020) Office for Financial Research, accessible at:
https://www.financialresearch.gov/about/ access date: 3rd February 2020
104
26
signify weakness as comprehensive regulation should leave room for contingencies111 within
the legislation itself. In this case, it remains to be seen whether RFB will retain permanence
in America.
4.2: Graphical representations of the effectiveness of American RFB
112
Despite the aforementioned restrictions set out by the “Volcker rule”, this graph represents
the significance of trading, or securities exchange in direct contradiction of the fact that these
activities should not be conducted by the same holdings company. This indicates that illicit
exchange activity is still prominent amongst American banks who also partake in commercial
functions. This means that breaches are already beginning to occur in favour of profit in the
corporate governance model of respected institutions. This evidences shareholder value
driven banking policy culminates with the laissez faire legislative approach promulgated by
Trump113 in order to increase the extent of securities activities since the inception of DoddFrank. The graph illustrates how growth has been encouraged at the expense of adherence to
the legislation and poorly enacted powers by the FOMC.
K Pistor and C Xu, ‘Incomplete Law’ (2003) New York University Journal of International Law and Politics
Vol. 35, No. 4: 931-1013, 932
112
Bloomberg LP, ‘The Volcker Rule’ (2019) Bloomberg accessible at:
https://www.bloomberg.com/quicktake/the-volcker-rule access date: 4th March 2020
113
Dennis Kelleher, ‘Trump’s Assault on Financial Reform’, (2019) The American Prospect accessible at:
https://prospect.org/economy/trump-s-assault-financial-reform/ access date: 14th January 2020
111
27
This graph is indicative of the inadequacy of consumer protection relating specifically to the
mortgage aspects of retail banking. It offers an important insight considering the extensive
impact of sub-prime mortgages collapses to banks immediately before the economy crashed.
Dodd-Frank’s attempt to address this issue, from a consumer side, came in the
aforementioned CFPB and s1405 of Dodd-Frank114. As the graph shows, the extent of
overvalued or sub-prime mortgages has diminished, indicating benefit from a consumer side.
Moreover, since its inception, the bureau has been an unmitigated success. “For every $1 of
funding, the CFPB has returned approximately $5 to victims of financial wrongdoing; to date,
it has returned nearly $12 billion to 29 million wronged Americans. Consumers have also
114
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) P.Law 111- 203, 124 STAT. 2141,
s1405(1); Ibid. see Title XIV: Mortgage Reform and Anti-Predatory Lending Act
28
benefited from decreases in high-cost mortgages115”. Therefore, it may be ascertained that
Dodd-Frank improved standards for safe mortgages and achieved its intention behind the to
make sure America’s families could not be taken advantage by predatory companies. Highcost mortgages, as a share of total mortgages, have declined significantly since the financial
crisis. This indicates improvement in preserving the value of wages considering the
significance of mortgage debt to income ratio at an approximate 23-35%.
116
The above diagram portrays a general decline in the cost of personal loans to consumers of
American banks along with the rates paid on credit card debt. This trend is further supports
the previous diagram to suggest that the CFPB has improved conditions for bank customers.
With this said, the red trend line indicating rates paid on personal loans was already in
decline from the advent of GLBA which removed RFB under Glass Steagall. In this case, it
G Gelzinis, M Zonta, J Valenti and S. Edelman, ‘The Importance of Dodd-Frank, in 6 Charts,’ (2017) Center
for American Progress, accessible at:
https://www.americanprogress.org/issues/economy/news/2017/03/27/429256/importance-dodd-frank-6-charts/
access date: 3rd March 2020
116
Board of the Federal Reserve System, ‘Consumer Credit – G.19: Consumer Credit Historical Data,” (2017)
available at: https://federalreserve.gov/releases/g19/HIST/default.htm access date: 17th February 2020
115
29
may be suggested that the re-introduction of RFB has not affected the trend and therefore
bares little impact on consumer loans despite the increased regulation on banking practice.
117
Community banks are a central aspect of economic prosperity and stability. They provide
lending opportunities to small-scale, regional businesses and support to local clients who
wish to operate beyond major banks. Furthermore, the widespread claim that community
banks suffer under the Dodd-Frank’s stipulations118 is merely a façade to justify the
progressive roll-back of financial reform. However, these graphs highlight that post-financial
crisis regulation, under the passage of Dodd-Frank, the declining trend remains consistent
rather than worsening as a result. This is reflective of the fact that RFB is at least no worse
for small-scale banking than the deregulated system which preceded it.
4.3: United Kingdom’s RFB policy
Federal Deposit Insurance Corporation, “FDIC Community Banking Study Reference Data” (2017) FDIC,
available at: https://www.fdic.gov/regulations/resources/cbi/data.html access date: 3rd March 2020
118
House of Representatives Committee on Small Business, ‘Where are We Now?: Examining the Postrecession Small Business Lending Environment’ (2013) US Government Printing Office, p – 53; Marshall Lux,
‘Dodd-Frank Is Hurting Community Banks,’ (2016) New York Times, accessible at:
https://www.nytimes.com/roomfordebate/2016/04/14/has-dodd-frank-eliminated-the-dangers-in-the-bankingsystem/dodd-frank-is-hurting-community-banks access date: 12th February 2020
117
30
The structure of banking legislation in the UK has evolved somewhat separately to its
European counterparts due to legal restrictions adhering to banking deregulation since
‘Lawson’s boom’ and manifesting in concurrence with the US over the last century119. This
has meant that the effects of the financial crisis were different, arguably being more
profound, than the experiences of other EU member states. To ellaborate, the cost of the
Depression to HM Treasury has been estimated at £1.2trillion120 or almost 80% of 2008’s
GDP. Furthermore, reports from the outset pre-empted that the UK would incur the largest
deficit increases as a result of these bail-out responsibilities121. This illustrates the importance
of RFB here. Arguably huge liabilities, gained through government spending on bail-outs
under the UK’s Financial Services Holdings company, warranted a total overhaul of the UK’s
universal banking approach.
The UK’s new RFB policy has since been explicit and widely-encompassing. This translates
to some of the most comprehensive global banking regulation, adhering strongly to the ICB’s
central focus on “financial stability and competition.122” Broadly, it prescribes that deposittaking activities must be segregated from investment and other risk-prone functions from 1st
January 2019. Retail banking must now be conducted amongst other limited activities within
the ‘ring-fenced body123.’ This insures that activities which are “critical to the operation of
the real economy” are protected124. As such, the implementation of new Banking Reform Act
legislation offers the most revolutionary legislation in UK financial services industry. It
comes second only to MIFID II and has surpassed Brexit in cost, complexity and
resources.125 This is a consideration which gives further grounds to the strategic importance
of Ring-Fencing. Arguably, the strength of UK RFB regulation, compared to other western
119
Kern Alexander, Principles of Banking Regulation (2019) Cambridge University Press, p - 212
Federico Mor, Bank rescues of 2007-09: outcomes and cost, 8th October 2018, House of Commons (Briefing
Paper) p – 5; National Audit Office, ‘The Comptroller and Auditor General’s Report to the House of Commons’
(2015) HM Treasury Resource Accounts - 2012-2013
121
Directorate for European Economic and Financial Affairs, Economic Crisis in Europe: Causes,
Consequences and Responses (2009) European Communities, p – 41 accessible at:
https://ec.europa.eu/economy_finance/publications/pages/publication15887_en.pdf (accessed 12th February
2020)
122
Independent Commission on Banking (‘ICB’), ‘Final Report: Recommendations’ (2011) (Working paper) p
19 - 20.
123
Thom Wetzer, ‘In Two Minds: The Governance of Ring-Fenced Banks’ (2018) Journal of Corporate Law
Studies; Financial Services and Markets Act (2000) (‘FSMA’), as amended by the Financial Services (Banking
Reform) Act (2013)
124
Independent Commission on Banking (‘ICB’), ‘Final Report: Recommendations’ (2011) (Working paper) p
35-40.
125
John Holt, ‘Foreign banks stand to benefit as ring-fencing deadline hits’ (2019) KPMG accessible at:
https://home.kpmg/uk/en/home/media/press-releases/2018/12/foreign-banks-stand-to-benefit-as-ringfencingdeadline-hits.html accessed: 10th January 2020
120
31
regions, renders it internationally desirable as well as a potential limitation to the
competitiveness of UK banks. Notably, the regulation covered, at first instance, 7 ‘core’
banks which are effected with deposits exceeding £25billion (averaged over a three year
period); Barclays, Co-Operative, HSBC, Lloyds, RBS and Santander. This means an
estimated minimum of 75% of UK consumer banks126 now enjoy £85,000 in retail deposit
protection127. The coverage offers clear indication of explicit limitations on the scope of
responsibility for governments; future bail-outs may be targeted to economically essential
deposit-taking activity. It is equally expressive of specific coverage of retail banks which has
been made possible only by isolating commercial banking from riskier functions.
On deeper analysis, the ICB’s advisory report, coupled with amendments from the
Parliamentary Commission128, laid the basis for the Financial Services Act 2013 (‘Banking
Reform Act’), along with discretionary powers to combat bank mismanagement. Notably, the
Banking Reform Act gives specific roles to the Prudential Regulation Authority (‘PRA’) and
Financial Conduct Authority (‘FCA’) to ‘implement and develop ring-fencing policy129’ such
as the aforementioned consumer protections. This identifies a clear strength in the regime
because institutional discretion theoretically has the capacity to adapt to changes in
governances issues which are faced. However, when considering the loosening of restrictions
which can occur among regulatory bodies with discretionary power (mentioned in chapter
2.4), it could also signify an absence of permanence in the UK’s RFB legislation. Once more,
this is important because for regulation to be complete, ex ante and prepared for all future
contingencies130, it should not provide a wide role for discretionary bodies to determine
future directional changes. Furthermore, the PRA’s advocacy that banks ‘should’ pursue
Referring back to the Banking Reform Act, legislation lacks clarity in select areas.
Specifically, although some areas are explicit, some degree of judgement must be applied to
excluded banking conduct under the act. This is a notable weakness because it mirrors was
how uncertainty was birthed under the original precedent for international RFB legislation in
K Britton, Quarterly Bulletin q4 – 2016 (2016) Bank’s Major UK Deposit Takers Supervision Directorate, p
– 164
127
Financial Services Compensation Scheme, ‘Banks and Building Societies,’ FSCS accessible at:
https://www.fscs.org.uk/what-we-cover/banks-building-societies/ accessed: 3rd January 2020
128
Parliamentary Commission on Banking Standards (‘PCBS’), First Report: First Report of Session 2012-13,
HL Paper 98
129
Financial Services Modernisation Act (2000) s142H, amended by Financial Services Act (2013) s4(1)
130
K Pistor and C Xu, ‘Incomplete Law’ (2003) New York University Journal of International Law and Politics
Vol. 35, No. 4: 931-1013, 932
126
32
America’s Glass-Steagall act. Moreover, the act refers to hedging exceptions131 liquid asset
exceptions132 and collateral exceptions133. These are areas which require discretion to
determine if conduct comes akin to a breach of the ring-fence and must be elaborated upon in
greater detail as the RFB legislation evolves.
European changes following the financial crisis
European legislation is broadly encompassed by an adherence to the Global jurisprudence
considering the extent to which banking policy has been assimilated from G-20 and the US.
Driving for change in G-20, they adapted the Financial Policy Committee to the Financial
Policy Board (FSB) which underscored genuine policy reform. Basel III was the eventual
masterpiece of a turn towards the promotion of banking regulation which set out a system of
macroprudential reforms in 2010 in order to maximise economic stability. Since, Basil III has
implemented a “ Total Loss Absorbency Capacity” system134which assures that risk-prone
banks of strategic importance are responsible for the failure of these ventures. In this
approach, government bailouts will be funded by equity gained in the bailed out bank135.
NOTES
As a result, the Spanish banking sector has undergone extensive restructuring and
consolidation. In the 2008–16 period, the number of credit institutions (excluding foreign
branches) declined from 195 to 125 (Graph A.1, left-hand and centre panels), while total
domestic banking system assets fell by around 20%. Consolidation was concentrated among
savings banks, whose numbers fell from 45 to two. Some savings banks were acquired or
131
The Financial Services and Markets Act 2000, Excluded Activities and Prohibitions Order (2014) rr 6, 14
Ibid. rr 6(3)(a)
133
Ibid. rr 6(3)(b), 14(5)
134
Financial Stability Board, Adequacy of Loss-Absorbing Capacity of Global Systemically Important Banks in
Resolution – Consultative Document (Nov. 10, 2014), www.financialstabilityboard.org/wpcontent/uploads/TLAC-Condoc-6-Nov-2014-FINAL.pdf.
135
Jeffrey N. Gordon, Wolf-Georg Ringe, Bank Resolution in Europe: The Unfinished Agenda of Structural
Reform (2015) The Center for Law and Economic Studies Columbia University School of Law
132
33
absorbed by commercial banks or other savings banks, others were integrated into an
Institutional Protection Scheme (IPS) or merged, with eight of the resulting saving banks
being transformed into commercial banks (following a legal reform). In several cases, the
integration processes involved more than one stage. Consolidation also occurred among
cooperatives, with the main process being the establishment of an IPS that brought together
19 credit cooperatives. These changes have led to an increase in banking system
concentration, with the domestic assets of the top five banks accounting for 65% of system
assets in 2016, up from 51% in 2008.
Structural adjustment is evident in bank distribution networks, with branch and employee
numbers declining substantially (Graph A.1, right-hand panel), and staffing costs falling by
24% from 2008 to 2016. Bank balance sheets have been substantially strengthened, notably
capital buffers, with the aggregate Tier 1 capital ratio rising from 7.8% in 2008 to 12.8% in
2016.
34
Figure 2:
35
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36