21 November 2008

MLex Comment - Retail banking regulation after the state bail-outs

In recent years the debate on retail banking regulation has focussed on specific issues such as account mobility, payments and card fees, but with profound structural shifts underway in the industry, the discussion may be set to change. Those regular topics will remain on the agenda, but the over-riding involvement of the state will leave a lasting imprint on the retail sector where it looms large in an often competitive commercial world.

Reporting on the state of retail financial markets in January 2007 (see here), the European Commission continued its battle against payments cards fees and came up with softer measures to enable bank account mobility and financial literacy. While these are all still valid concerns, the regulators are looking at a different landscape now from January 2007.

Once large European commercial banks started hitting the wall this autumn directly after the collapse of Lehman Brothers it was evident that state involvement would ensue. While this was meant in part to ensure macro-economic stability, the micro-economic effects on the high street may be just as severe.

While partial state ownership is now par for the course, current and future merger activity is likely to determine what kind of banks we are likely to see in the coming years, what kind of service levels they will be able to offer and how their product range will be affected. Indeed,the commission may get its wish of seeing greater cross-border activity as banks see an easy way to enter foreign markets by snapping up ailing banks. This could lead to more cross-border retail offerings.

There are already practical recent examples. First, on state involvement: In the UK Northern Rock caused a great deal of concern on the domestic market by offering deposit rates above the norm. Eventually this had to be reined in by the authorities as commercial banks complained of the state creating an uneven playing field. 

The German rescue package has similarly caused a stir in the banking market in Germany, albeit for slightly different reasons. Here there is a clear reluctance on the part of 'commercial banks' – those not belonging to the savings and co-operative bank sector - to tap into the recpitalisation programme for fear of being labelled a badly-run bank. Only one commercial bank had accepted state money up to very recently (Commerzbank). Even in this case, it was only carried out sheepishly and later on in the day. Interestingly, the savings and co-operative banks have not shown the same degree of reluctance in coming forward.

Other markets too, have shown wildly varying responses to state rescues with certain banks such as Erste Bank and HSBC availing of fresh capital in order to boost their core capital ratios. A high Tier 1 capital ratio is becoming the be-all-and-end-all; even healthy banks are electing for top-ups, in order to remove any hint of capital flight by investors.

While the current policy responses by European governments to the crisis seem to be reactionary, the taxpayer, who has offered up the cash to bail out the banks, is now demanding the state take measures to ensure retail stability. Recommendations on maintaining credit to households and small businesses at pre-crisis levels are all actively being pursued and remain likely to be enacted.

The danger with such proposals is that, though well-intentioned and logical, they fail to consider market dynamics, the specificities of retail or other relevant local factors. This could be problematic in the medium-term.

Imposing draconian prescriptive controls on banks’ use of capital, banks' risk-taking and overly favouring banks’ customers vis-à-vis credit, could amount to a recipe for disaster. And this is before factoring in serious competition headaches that will inevitably arise from the various ‘shotgun wedding’ style mergers, the deep distrust of bankers among the public and the raft of legislative measures in the pipeline.

So what would be the best-case scenario to achieve a balanced outcome whereby retail confidence is restored, consumers rights are protected and banks return to suitable business models?

One: consider revising the loan-to-value ratios for mortgages EU-wide, and encourage banks to bring down their own deposit/lending ratios. Some pioneering member states already have restrictions in place that homeowners cannot go above a ceiling i.e. 80 percent loan-to-value ratio. Moreover, making banks take in more deposits would allow them to store up cash which could be used to offset any potential heavy bad debt losses.

Two: keep prioritising the role of consumer education initiatives – this would assist the ongoing education of consumers on financial matters and would go some way towards restoring confidence in banks more generally.

Three: seek reassurances on the costs of basic banking services, i.e. do not permit banks to jack up fees, as some have already done, to business owners and retail consumers. This can act as a brake on economic activity.

Four: consideration could be given to possibly allowing the regulator to 'certify' that banks have no hidden toxic assets on their books – this procedure could facilitate functioning of the inter-bank lending market which is still crippled. In this way one could go far towards rectifying credit shortages to retail customers.

Undoubtedly, banks have made grave errors in operational policy, mostly on the investment side. Foolish securitisation losses are affecting retail business markets. But should innocent consumers and small-scale shareholders have to foot the bill? 

Why not aim for an industry-led march to a sensible deposit-loan banking culture, continuing consumer education and maintaining product offerings? Thereafter officials can intervene on competition and other structural issues which may arise, on a case-by-case basis.

By Kevin Newman

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