Retail and Investment Banking in the UK - Essay Example

Retail banking Vs Investment banking in the UK Introduction In ordinary banking system, there are corporate and individual customers who require different financial services. For individual customers drawn majorly from the public, the banking activities include: deposits, personal and development loans and credit and debit card services and mortgages (Barr, 19, December 2011). For the corporate customers, the services include: ancillary services, investment capital and financial services in a case of a merger or an acquisition. This is the traditional face of banking. However, in the wake of changes that are occasioned by globalization and innovation, the face of banking is slowly changing to accommodate the available opportunities. Even though the face of banking may change, the functionality may not be altered in many cases. This therefore means that the need to come up with strategies to accommodate the change is necessary. One of the strategies that are brought forward is the use of separation of investment banking from the retail section of banking. Discussion Separation of investment banking and retail banking Separation of retail banking from investment banking is a strategy that is required as a measure to increase financial stability within a national economy. In this separation, the banks either specialize to perform retail or investment banking in an arrangement known as ring-fencing of the banks (Coppola, 5, September, 2014 ). In this arrangement, a local subsidiary of a bank that takes the deposits of local customers is protected from the parent corporation through trade bans and deposits security mechanisms (Song 2004, pp 19). In this way the deposits of the local customers are protected from external shocks of the economic uncertainties that the large international corporations could have exposed them to. In Great Britain (2012, pp11), the rules that set up the conditions for ring-fenced banks are listed. These rules set the prohibitions that are set for the banks that are set by the regulating authority. In this essay, the effectiveness of the separation of retail banking and investment banking are discussed. The focus of the essay remains if the separation can really bear intended fruits or collapse and the possible consequences of the separation. Investment banking provides services and funds to different sectors of the economy. In doing this, investment banking exposes utilizes the financial capital that is majorly drawn from the savings or deposits of the clients. It means that in a worst case scenario, if the economic forces force the investments to collapse totally, then the bank is faced with insolvency. The deposits of the clients disappear and the bank will require to be resolved by the relevant mechanism and organizations (Davies, 6 May 2012). This scenario depicts of an unstable economic environment that will make the confidence of the general public dwindle in the financial institutions. The other issue that is related to this is in the case where the collapsed bank is a subsidiary of some large international bank and the body that is charged with bailing it out is the government. In this case, the public is burdened by a mistake that is maybe due to the flaws of the parent bank in some other economy different from the local economy (Davies, 6 May 2012). Ring-fence banking To protect the taxpayer from paying the debt of such financial institutions, in the UK, the independent commission on banking developed a proposal in 2011 that introduces a ring-fencing requirement on the large international banks operating subsidiaries in the UK. The ring-fencing requirement also came with the dos and don’ts of trading for these subsidiaries with the aim of protecting the public deposits increase the banks’ ability to absorb risks and improve public confidence in the financial institutions (Turner 2014, pp206-208). The proposal effectively separated the functionality of investment banking from those of deposit taking and savings. To gauge the effectiveness of this form of banking system, the review of its modalities in different settings and contexts is necessary (De vries 2013, pp 4)). This gives an understanding as to whether the arrangement is effective and helpful or if it is moving in the opposite direction to modern trends in the banking sector. To begin with, there are no international practices that exist to standardize this arrangement; however, different banking groups apply this kind of set up in their operations (Song 2004, pp 18). The major aim of the arrangement is to provide the public with a structured banking that separates the functionality of international risks with the social responsibility of utility to the public. In this study, the banks responsibility to the larger source of deposit, which is the community, is the cause of concern on the implementation of the ring fenced banking system. As part of the wider implementation of the ring-fenced banking system, there are some European banks that have devised modalities to regulate the transfer of assets within the group of companies across borders that could be informed by the parent of the subsidiary. The aim of this kind of arrangement is to prevent the problems that can arise from disproportionate transfers (Reinholdson & Olsson, 2012, pp 37). During the resolution of the banks, the ease is enhanced not due to the trading prohibitions that are imposed by the regulations of the ring-fence but due to the security of the deposits. Under UK regulations the banking requires higher capital to operate as a ring-fenced entity. This gives it higher security for the deposits than the investment banks (Ghate et al. 2014, pp127). The basic intention of this regulatory requirement is to increase the capital base for stability purposes of the bank. This is achieved through making the banks less costly to resolve whenever in crisis and the prevention of external economic shocks to the financial system (Turner 2014. Pp 207). Importance of ring-fence banking in risk management For management of risks and hedging, the ring-fenced banks rely on the contracting arrangements that are made within the group (Halligan, 10 Sep 2011). To limit the chances of failure that comes with the faults of the wider group, oversight measures and prudential arrangements are availed and implemented that prevent the ring-fenced entity from going down with the overall group (Chow 2011, pp28). As a requirement, the maintenance of a portfolio that illustrates the implementation of secured lending securities and the bank must be counterparty to the contracts of its derivatives. The discussion on the various modalities about the modality of operation of the bank illustrates that fact that the separation of the banking system is a viable mechanism that can be used to achieve the objective of financial stability within an economy (Treanor, Monday 12 September, 2011). The security of insured deposits make the banking modality favorable for securing the investments and savings of the general population from the adverse effects of global economic challenges that are occasioned with the harsh international investment macro-environment (Herbst, May 2011). As a fact the implementation of the insurance policy or the risk management and the protection of transfer of assets as depicted in the control of some European banks will make the arrangement even more stable in dealing with the liquidity or solvency related issues (Schmeider et al. 2010, pp4). The introduction of the bank also brings about more risk absorbing capacity due to the specific features that have been discussed here. This includes the protection from the external investment risk environment, risk management through secured deposits and prohibition of trading with external entities directly. In a case where banks have a high ability to absorb losses, the resolvability of the banks also increases (Krainer 2000, pp 17). Challenges However, there are no systems that are without criticism. Flaws must always emerge as this method of banking is slightly a new system of banking that was incepted a few years back. In as a much as the separation of banking provides a level of security to the general public and taxpayer through ease of resolution in times of crises, the proposal for separation is a misconception of the actual problem that led to the crisis of the great crash in the first place (Turner 2014, pp 207). It notes that the problems that led to the great crash were lending that covered both retail and commercial banking sectors. It would therefore be inaccurate to single out the external economic shocks as a cause of the crisis. In this context, the separation of investment banking from retail banking and implementation of ring-fenced banking system only serve to rob the economy of the power of growth through investments and does not resolve the underlying issues of banking crises (MP, 14 June, 2012). WandhöFer (2014, pp 22) furthers the debate that the proposal had erred in making its claims. It states that a critical analysis of the proposal is likely to change the structure of the banks to compromise on the competitive nature of the banks (Krahnen 2013, pp 30). According to this submission, the structure of the bank is not proven to have had any implication on the creation of the crisis that led to this reforms that were instituted. It further illustrates the fact that the various trading bans that have been proposed in Europe might trigger a long range of changes in the business model of banks across different economies that might not be absolutely necessary. In other studies, the political aspects of the proposal are examined. Fujita (2013, pp 104), opines that all the components of the proposal were carefully thought out strategies to resolve the crisis. However, the problem is with the date at which the implementation of the proposal is supposed to be in place. That is in the year 2019. The study indicates that this was somewhat a political decision taken by the coalition government. The intention of this decision was for the purposes of lobbying in order for the proposal to seem acceptable to a vast majority (Osborne:, 19 December 2011). The use of public funds is also a concern. Even though the implementation of a ring fence reduces the risks and makes the banks easy to bail out, the use of public money to redeem institutions that squander resources in the pretext of providing credit to the public is irresponsible. In this scenario, the arrangement is still not a perfect setting to solve crises relating to banking credit management. According to the World Bank (2008, pp 90), the separation of a subsidiary from the parent organization is not one of the best policies to apply while dealing with modern corporations. This is due to the fact that the corporations at time inject a huge amount of money in the subsidiaries in order to save face or maintain reputation (Mathieson & Schinasi 2000, pp176). It also describes the motivation behind this support and the factors to be considered before this support is given. These include the pressure to make profit and the financial muscle of the parent corporation. A parent corporation under pressure to make profit in the new market is not likely to bail a struggling subsidiary. However’ if the intentions of the parent corporation is to have a sustained presence in the market, then the chances of bail out is very high. In a case where the parent country is the cause of the subsidiary’s problems, it is only impetrative that the taxpayer of that nation takes responsibility of the woes. Ryder (2014, pp 190-194), gives an account of the various white collar crimes in the recent times in the UK. These include the LIBOR scandal that was looked into by the Wheatley investigation among others. From these white collar crimes, it is possible to suggest that white collar crimes often change shape but remains fairly similar. Turner (2014, pp98), refers to the innovative nature of the bankers and their ability to work around rules and regulations to their benefit. It is possible to state that the trading bans will serve no purpose once the bankers can devise code to beat the logic created by the regulations. Moloney (2014, pp 541), describes the criterion of selection of the banks that would be subject to trading regulations and ring-fencing set up if the proposals are implemented. It demonstrates that the selection will be a systematically skewed towards Europe’s large international credit institutions that are global in nature. Due to this, the possibility of change in structure and business model would subject the institutions to unfair competition from other multinationals in regions where the separation between deposit taking and investment banking functions is not done. Conclusion In conclusion, separation of deposit taking functions and investment banking are subjects that have drawn both criticism and support from different quarters. The proponents of this school of thought believe that the separation poses a number of benefits to the banking industry. The benefits that are supported by this argument include the separability during crises, and the confidence of the general public. Due to the separation, the separate sections can be resolved separately and easily without interference with the other. The deposits of the customers are also well protected in this arrangement. It is important to note that if a bank takes global risk of investment with the local deposits, the macro-economic environment might shift at a high rate leading to loss of the customer’s deposits. A possible question that arises is who gets to pay the depositors their money. Thanks to ring-fencing, the large international corporations are not allowed to gamble with the deposits of the public and the deposits are also protected from the adverse effects of external economic shocks (Chorafas 2014, pp37). Taking these gains in to consideration, it would be possible to state that the separation of functions in the banking industry through ring-fencing is ideal for solving some of the crises that have plagued the banking industry in the UK due to the modality’s capability to absorb risk and improve the confidence of the public (Dixit 2014, pp 98). However, the opponents of the separation believe that the system is not a solution to the troubles of the banking industry. The belief that the separation might have additional costs associated with administrative and business management is the general driving force behind this school of thought (Narain et al. 2012, pp 217). Other disadvantages that are cited include remodeling of the structure of the banks business model and the effects of the new structure on the competitiveness of the large banks. As a result the proposed changes that were to apply a ring-fencing model on banking are seen as discriminatory to large European banks in the competitive front. Finally, it is important for the different multi-national regulators to develop a universal review of the different banking sectors across national economies. This will help the regulators develop a universal approach that could help avert crises in the banking industry and reduce the discrimination that is skewed towards large financial institutions. References Barr, R., 19, December 2011. U.K. seeks to separate retail, investment banking. 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