Ares and Co

How stupid is it to separating Retail Banks from Corporate and Investment Banks?

The politicians of this world seem to have found a formula to save the Banks… and cut the “evil” forces which for them created the current mess.

There are several variations around the theme, between the US (Dodd Franck Act, the Volcker rule), the UK (Vickers report) and Europe (Sarkozy Merkel).  Many confusing things are being said but it covers substantially two concepts: the separation from proprietary trading from trading for clients and the separation of Retail Banks from Corporate and Investment Banks.

We are very surprised of those “claims” for many reasons:

• The trading on equity, bonds, etc., and their derivatives are originally based on a basic need for the stock or for hedging of the volatility risk.  The efficiency of the markets is also based on the market makers who insure the liquidity of those markets. If the market making activities are now far greater than the basic need, so what? But if it is separated, when how will that be efficient, and how companies will cover their risks? Probably at a higher cost. All speculative activities in one cell, then this probably another organized casino disconnected from the real economy.
• Separating the Retail Banks from the CIBs is a common opinion based on the idea that it would protect the individual depositors from the risk of bankruptcy generated by the speculative activities of the retail Bank. Did this ever exist? Every time it was close to it the Government stepped in to avoid it. The last case, i.e., Northern Rock in the UK, it is the shortcomings in the liquidity was not created by the CIB but by a poor ALM management of the Bank. The only losses in depositors’ money may have occurred in the US for small banks, but the FDIC compensated for most of it, and for the unfortunate, and for a long time fortunate, Madoff’s customers, for reasons that have nothing to do with the case put forward by politicians.

Apart from the fact, that few can recall a case where deposits are lost due a bank failure, the drawbacks of separating the two sides of the house are some compelling questions:

• Management is about balancing the risks and the cycles of revenue to they could combine themselves in a more predictable outcome. If separation occurs where is the balance of risks? Look at the volatility of profits, there are quite significant in the CIB side, and relatively limited in the Retail side.
• When a bank finance itself on the markets, then the entire balance sheet size counts, smaller balance sheets, more liquidity issues will arise,
• What are today, the true imbrications of the two businesses: certainly on some aspects of the liquidity management, the risks limits and on the Shareholder’s equity,
• From firsthand experience in separating ABN Amro into RBS wholesale et Fortis Retail, the complexity of splitting two banks is just enormous, specifically when it comes to the operating functions (payments, accounting, etc),

Controlling the CIB speculative behavior and the implicit connections that exists in some case between the sale and the buy sides, or debt structuring side, are certainly desirable objectives. It seems to us that the drawbacks of the separation are far greater than the current status quo, which can certainly be improved by some measures as the equity constraints dedicated to some activities.