02 October 2012

Andrew Haldane: We should go further unbundling banks

Structural reforms to banks are high on the agenda, with the Liikanen Group's call for European banks to separate retail from trading activities. For some, such calls are a cause for concern. Yet for investors, the concern should be that they do not go far enough, writes Haldane in this FT article.

Lowly bank valuations are in part a legacy of the past and in part a prophecy about the future. The legacy is the overhang of overvalued bank assets. There are several reasons for this. One is forbearance on past loans, which appears to be both large and latent. Quite how large and latent is unclear. Near-zero global interest rates, actually and prospectively, have encouraged forbearance by lowering the costs of prevarication. Global accounting rules have also contributed to an overvaluation of legacy assets, as they prevent banks adequately provisioning for future loan losses. International efforts to rectify this are at risk of stalling.

There is a strong case for regulators stepping in to lessen the uncertainties over valuations. That might mean calculating prudent valuations across banks’ balance sheets, as the Bank of England’s Financial Policy Committee recently suggested with respect to UK banks.

These prudent valuations would help in removing residual uncertainty about banks’ legacy portfolios. They could thereby spur private investors to return to banks, when they might otherwise be fearful of paying for yesterday’s mistakes. That would boost bank valuations and support bank lending.

At present, investors are pricing for a migraine. Market prices suggest the banking whole may be worth less – in some cases much less – than the sum of its parts. There are market-implied diseconomies of scale and scope. The problem for investors appears to be not so much too-big-to-fail as too-complex-to-price.

This was last the case in the depths of the Depression. Then, mirroring recent experience, US bank price-to-book ratios fell from above two to well below one between 1928 and 1933. This set the stage for the Glass-Steagall Act, a market-induced but regulatory-enforced unbundling of the banking portfolio.

Today, the Volcker proposals in the US, the Vickers proposals in the UK and the Liikanen proposals in Europe envisage a similar unbundling of banking portfolios. Despite the alarm some have expressed, if implemented faithfully and simply such structural solutions ought to help solve the too-complex-to-price problem, to say nothing of too-big-to fail. Alongside efforts to strengthen macro- and micro-prudential regulation, these initiatives would help mobilise bank funding and lending, just when it is most needed for the economy. 

Full article (FT subscription required)

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