Operation "Merlin" and "Glass Steagall Bis"

On Wednesday, UK banks were in the spotlight for two main reasons. First of all, the preliminary disappointing results of operation "Merlin", a deal between the UK government and the large banks on bank lending targets. Second, the large private banks' reaction to the ring-fencing initiatives of the Independent Commission on Banking, this in order to make banks safer.

Operation Merlin entails an agreement between the UK government and the big 5 (Barclays, RBS, Lloyds, HSBC and Santander) to increase lending to small and medium sized companies to £ 76 bio this year. Banks also pledged to boost overall business lending to a total of £ 190 bio. First results unveiled show that banks will come short about £ 3 bio of the overall £ 19 bio target in Q1. Business secretary Vince Cable stated that it was too early to judge operation Merlin as being a failure but warned that banks should raise their game. The obvious defense of most bank officials was that :

- Banks are not unwilling to lend money, there is simply no demand for it, target set too high under current circumstances.

- The governments' requirements for banks to hold more capital is also having an effect on overall lending and lending standards

- Banks are moving away from "relationship banking", meaning that at a time of crisis they don't have the infrastructure to properly assess the risk of lending to small business.

Especially this last argument is a nice one, since we thought that moving away from relationship banking brought us into trouble in the first place. How the government will take action to push banks towards their targets is also not clear but never mind, let us now turn to the banks counter-arguments on ring-fencing. The idea of ring-fencing - ie build a wall around retail operations or separate investment banking from retail banking arms - is not new, cfr US Glass Steagall act 1933. It basically tries to prevent banks from gambling with retail depositors' money. The big 5 banks however have their own separate point of view. Let's just have a look at some comments given yesterday, in some cases painfully hilarious.

Bob Diamond of Barclays :"Our bank was a stabilizing force throughout the financial crisis (note : Barclays ranks 11th on worldwide toxic assets writedowns for an amount of $ 45 bio while its share plunged from 700p to 100p in between 2008 and 2009) ; An extreme view of ring-fencing makes an implied government guarantee almost explicit. The worry I have is if UK retail deposits could only be invested in UK assets. Just have a look at what happened with German Landesbanks and Spanish Cajas".

More confronting however were the comments coming from Stephen Hester, replacing Fred Goodwin as CEO of RBS (note : 84% controlled by UK taxpayers after massive government bail-out, RBS no5 on toxic asset writedown $ 71 bio) : "Breaking up banks' activities ? Size does not matter. A big bank does not automatically pose a systemic risk, a bank that takes big risks does. On ring-fencing, I totally agree with Bob Diamond. There is a risk of moral hazard if you create a protected beast while other parts of the bank are not. On the question how tax-payers bailout money has been used, I can only answer that the subsidy could have fed through a lot of places - the price of loans, the general economy and bonuses (BBC flegmatic comment : this remark could be viewed by some as scandalous, by others as a statement of the obvious).

Putting 1 and 1 together and we get a sober conclusion. RBS favors a limited form of ring-fencing based upon remarkable arguments in view what happened to the bank in 2008-2009. It basically prefers to use its liabilities to invest in other things than loans to for example domestic Small & Medium sized companies. And this comes from a bank which was bailed out by tax payers' money at a time its balance sheet was for more than 50% filled with foreign lending. As a UK taxpayer, I would feel very uncomfortable with this knowledge in times of crisis.