Shall We Separate Retail Banking from Investment Banking - Literature review Example

Introduction The most debated critical issue among developed economies is about banking reforms after the global financial crisis of 2008. Vickers (2012) argues that the combination of retail and investment banking increases the failure risks associated with the banking system which in turn leads to different financial crisis. The debate is over the implementation of suggested reforms in terms of splitting the universal banking model which includes both investment and retail banking sectors under one roof. The main suggestions are about employing ring-fencing techniques in retail banking to separate it from investment banking. Different proposals in the different countries are taken into consideration for reforming the banking structures as per suggestions. The structural debates of reforms in US are for applying Volcker rule for separating propriety trading from banking while in UK is for separating retail and investment banking by applying ring-fencing measures (Vickers, 2013). However, Great Britain Parliament, House of Commons- Treasury Committee, (2010) maintained that the debate on structural reforms is comparatively high in UK due the matter of fact that UK industry is largest in size and highly dependent on foreign entities. With the above factors at work, the underlying paper is aimed to explore the implications of the separation of retail and investment banking. In addition to this, the current status of the global and UK banking industry, combine model and issues associated, different underlying separate banking model and ability to eradicate the current issues.The paper will be also bagged with the discussion of the possibility of separating retail and investment banking as well as the probable positive and negative outcomes of such actions. Scenario Building As discussed above, 2008 economic shock has alarmed institutions with the need of corrective actions thus once again aroused the debate of separating financial institutions in different regions with different theories (Vickers, 2013). Structural reforms are explored as the corrective measures for mitigating the banking failure risks in the future by separating inter-connected banking sectors. The said situation has opened the debates of workable alternatives, probability and possibility of separating said entities, as well as the outcomes of such reforms in both positive and negative directions for developed economies. With the above backdrop at work, four most talked proposal post recession inculdes Vickers report for UK, Liikanen report for EU other than UK, Volkers rule for US and most importantly OECD. All the reports were aimed to highlight the damaging consequences of combined banking model. OECD with the explanation of “too-big to fail” factor explained the need of seperated banking structure (Blundell-Wignall, Atkinson, & Roulet, 2013). While Volker rule was based on thr grounds of addressing the regulatory measures associated with the retail banking. It was maintained as suggestion that propriety trading should be sperated from retail banking to make the system safer (Tarullo, 2012). In the same regard, Liikanen report addressed the complexity of invenstment banking structure that threatens the overall system. It was maintained in the report realistically that complete reform is difficult however, general banking system should be seprated from risky trading transactions (Liikanen, 2012). Finally, concentrating on Vickers report that was particularly developed to propose reforms in thr UK banking sector. The report deeply iscussed the causes and effects of the all the tragic downfall and highlight the combined banking system as the culprit. Percieved reasons for sperating the banking system was highlighted in terms of mitigation of mitigate current and future financial risks associated with the banking system. The main reasons include increased liquidity and capital, increased loss absorbance, fortified risk management for the industry as well as governance measures and enforcement of more viable tools of management in regarded institutions. (Great Britain Parliament, House of Commons- Treasury Committee, (2010). In alignment with the Vickers reform proposal, UK government has passed the banking reform Act 2013 with the aim of reforming banking structures with the two major implications. The implications include ring-fencing which is the obligation of prohibiting all the investment regulatory activities by the UK ring-fenced bank. The Second implication is supervision of EEA, it was the supervisory statement 2014 aimed to authorization and supervision of non-EEA banks’ branched in UK for the purpose of financial stability of UK economy (Financial Stability Board, 2014 and FTI Consulting Strategic Communications, 2014). Analysis of Reforms in accordance with Banking Models Colvin, (2007) describes that beginning of 20th century witnessed the emergence of three parallel banking structures. These structures include separate commercial and investment as well as a combination of both named as universal banking model. All these remained in constant debates about evolution.Once again during and after the crisis period, the employed models of the banking industry were highly criticized; specifically the universal banking model was put on fire. Universal bankingstructure provides a combination of tailored services in terms retail and investmentsboth (Xiaoqiu, 2014). Quinn, (2012) maintained that universal banks are commercial with a large division of investment banking and integrate the complexities of investment banking with simplicity of commercial banking to create value thus incorporate higher risks. In alignment with the above explanation of universal banking system’s high risks for taxpayers and consumers, the discussion of separating the investment and retail wings of universal banking model is provoked. Treasury Committee stated that the vision of separating low-risk entities from high-risk entities is initiated in 1933 after great depression period by employing Glass-Steagall Act in US. However, practical feasibility of the concept is highly questioned to date. As reported in alignment with the concept that the measures of separating banking entities cannot address systematic risks because that risks are not outcomes of structures but with the failure of any single entity (ZEW, 2013). Additionally, Schildbach, Speyer, Hoffmann, (2012) discussing the aspects of universal banking argued the importance of universal banking system from interconnection benefits perspective. It was maintained that universal banks not only provide tailored services to the customers but also lower customers’ costs by employing economies of scale that traditional commercial banks cannot utilize. Further, universal banking system is more financially stable due to their diversification model. Further, the measures of customers benefits due to interconnectivity of the financial institution are highlighted which in turn may be affected as a result of separating entities by treasury committee. However, on the other side, Treasury committee exemplifying the Lehman Brothers’ case accepted that interconnectivity of the financial entities meant a lot. It was accepted that the viability of separating the entities in terms of mitigating the risks is associated with the interconnectivity of the firms. Additionally, it is highly criticized that separation of both of the entities is almost not possible due to narrow gaps in the entities (Gambacorta, and Rixtel, 2013). Further, it was maintained that logically systemic risks which are aimed to be mitigated by taking said measures cannot be addressed. As maintained, the systemic risks are initiated by the imbalance of equity capital, credit growth and short financing in capital markets, and there is no possibility that these risks can be mitigated by separating institutions (ZEW, 2013). Effectiveness and Consequences of Aimed Separation According to Vickers, (2013) a ring-fencing entity will separate the operations of retail banking from investment with its equity and loss-absorbing measures. However, it was argued by cable, (2012) that the structural reforms will only be viable once the full separation of the two systems is implemented. It was further noted that if the ring-fencing technique fails it will once again aggravate the situation and call for further reforms (Telegraph, 2012).Strongly restricted banking reforms are urging larger entities to separate their entities completely to cope with the survival challenges (Halligan, 2014). With the debate about theviability of the said reforms, some effective measures are addressed and maintained by HM Treasury, Osborne, Leadsom, and Department of Business Innovation and Skills., (2015). It was reported that it will make the financial system more flexible globally that will be beneficial for UK banking industry. Additionally, the decision would increase stability and transparency which will reduce the risk for overall financial systemic system. Additionally, Wilmarth (2014) maintaining the above notion highlighted the impact of decreased systemic risks in terms if positive incentives that are the outcome of high risks. However, on the other hand, (Schildbach, Speyer, Hoffmann, 2012) discussed that today modern banking is highly connected and the balance sheet based, investment banking and capital funding is the main need of the corporate sector clients it would be harmful to separate the entities for masses. Additionally, ZEW, (2013) reported that instead of mitigating risks, the strict reforms would decrease the valuable risk mitigation capability of connected banking business. In favor of separation, (ING Publication, 2012) maintained that taxpayer risk would be reduced in terms of crisis management by applying ring-fencing with international risk monitoring systems, managing governance of business and imposing regulatory conduct to reduce risks of future crisis. It was also maintained that savers and taxpayers would be protected by implementing bail-in debt and Basel III for the purpose of managing debt losses and liquidity management respectively (ING Publication, 2012). Disregarding the said effectiveness, critics argued that the reforms are highly inefficient measures for mitigating systemic risks. (Schildbach, Speyer, Hoffmann, 2012) stated that the forced separation of the universal model will decrease the power of banks which in turns ultimately reduce the availability of funding for businesses. further, (Great Britain Parliament- House of Commons Treasury Committee, 2010) maintained that non-narrow banks would be more dependent on wholesale funding, and the degree of risks would be higher which can ultimately lead to failures of the system due to the systemic nature of risks. It was also added that hedge funding would lead to problems from investment to retail to the insurance sector (Lang, and Schröder, 2013). Further it was maintained that such reforms will call the international industry on a single page of the policy to reduce the risk of conflict due to the disparity of laws. Finally, the decision will decrease the complexity of the banking structure and will be made supervision easier (Lang,and Schröder, 2013). However, the questions about the viability of inter-dependent financial systems of propriety trading and commercial retailing will remain under consideration (Lang,and Schröder, 2013). Impact Analysis from Scholars Perspective The implications in terms of advantages and disadvantages captured the attention of authors and researchers of the discipline. On one hand, many favored the viability and stability of reforms while, on the other hand, some authors argued that the reforms would decrease the diversity of operations and will increase the failure risks associated. For instance, Chow and Surti (2011) shed light on the plausible viability of ring-fencing technique in terms of coping with contagion risks. In the same regard, Montanaro, and Tonveronachi, (2011) stated that one size fits for all approach may not be able to produce an effective results and varying country specific implications can worsen the challenges, as a result. However, with the discussed arguments it is accepted that relatively low investment share universal models are more stable in the crisis time which is supported by many empirical evidences. Some of the major empirical studies that favor a highretail/low-investment structure are discussed in continuation. Nicoló, Bartholomew, Zaman, and Zephirin, (2004) suggests that the banks with the universal model provide wider range of services possess the capability to “over-compensate” higher risks. While, Demirgüç-Kunt, and Huizinga, (2010) found that a low involvement in investment activities is better for auniversal model in terms of coping with risks. In the same regard, Altunbas, Manganelli, and Marques-Ibanez, (2011) found that a low activity of investment increase a negligible risk to the model thus the separation in retail and investment does not matter meaningfully. The all above empirical evidences regards large banks while Köhler (2012) investigated the matter for smaller banks and found it worthwhile for smaller bank to increase non-interest investment activities in terms exploiting diversification. All the above empirical evidences highlight the importance and potential of hybrid banking system and suggest that there may be a better option to keep universal banking model with lower investment activities participation. However, there is another important aspect in the regard about impact of said measures on pension providers and consumers as being stakeholders of the system. Impact Analysis from Stakeholders’ Perspective As a general implication, it was suggested that taxpayer and society at large would be benefitted out of the measures but many critics and respondents disagree with the implications.PWC, (2014) stated current reforms requires complex reforms for the dealing with the pension schemes while the current acts lack defining the implementation measures for the purpose. Additionally, Morley (2014) discussed that pension savers will not be able to utilize their account due to insufficient details for the purpose ofnewly separated system. Consequently, pension funding firms are facing high challenges and claimed not to adopt reforms till the resolution of the matter by the regulatory. Morley (2014) discussed that pension savers who use their accounts are going to be disappointed. Further, people who are going to retire in 2015 will have to see the problem of tax withdraw their income. The problems discussed above are highly gaining attention of critics and raising the questions on the effectiveness of announced reforms. (Jelley, 2013) discussed the matter from banking organization’s perspective and discussed the need of reformations in pension schemes employed by banks. (Jelley, 2013) elaborated that the implication of separating pension scheme assets and liabilities from other than ring fenced group is imposed to be completely accomplished by 2026. He discussed the two possibilities of separating the entities and explained the complications associated with both of the techniques. The options he argued are to develop new schemes and transferring assets to that scheme or separating the two existing entities from each other. He discussed that it would a complex process for banks in terms of negotiation with and in terms of keeping aligned with the benefits of pension trustees. He further argued that complete separation of pension valuables in terms of assets and liabilities are difficult to be separated. All the above implications are highly important with respect to a larger population base which is benefitted by pension schemes and there is need of highly guided transparent system to aid the reformation of pension scheme in alignment with the reforms of banks. Conclusion and Managerial Implications The discussion above suggests that there are no any strong evidences that suggesting that recent financial crisis was due to universal banking model rather it was admitted that specialized systems were highly exposed during the crisis. Secondly, systemic crisis is more out of a chain failure due to capital structure measures and strong credit growth of an entity and not directly linked to the banking model. Further, size of entity or type of entity does not matter while crisis occurs. Thirdly, reforms are aimed to separate retail and investment banking to reduce the risks and protect taxpayers. However, it was unveiled that many argue that such reforms are damaging to the customers due to reductions in the cost and services leverage that is given by universal banking system. Further, the reforms are emerging as critical issue for pension providers as well as pension holders which in turns increasing conflicts with the authorities. Finally, it is implied by exploring the matter that banking reforms in terms of separating two tightly joint banking models cannot be easily implemented due to many technicalities of the current system. There is a collective agreement among many authors, critics, and researchers that a mix of both retail and investment activities could be a better option to be implemented instead of trying to separate the systems fully. 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