The JPMorgan problem writ large
By Howard Davies
Former Chairman of Britain's Financial Services Authority, Deputy Governor of the Bank of England, and Director of the London School of Economics.
JPMorgan Chase has had a bad year. Not only has the bank just
reported its first quarterly loss in more than a decade; it has
also agreed to a tentative deal to pay a fine of $13 billion to the
US government as punishment for mis-selling mortgage-backed
securities. Other big legal and regulatory costs loom. JPMorgan
will bounce back, of course, but its travails have reopened the
debate about what to do with banks that are "too big to fail."
In the United States, policymakers chose to include the Volcker
rule (named after former Federal Reserve Chairman Paul Volcker) in
the Dodd-Frank Act, thereby restricting proprietary trading by
commercial banks rather than reviving some form of the
Glass-Steagall Act's division of investment and retail banks. But
Senators Elizabeth Warren and John McCain, a powerful duo, have
returned to the fight. They argue that recent events have shown
that JPMorgan is too big to be managed well, even by CEO Jamie
Dimon, whose fiercest critics do not accuse him of
incompetence.
Nonetheless, the Warren-McCain bill is unlikely to be enacted soon,
if only because President Barack Obama's administration is
preoccupied with keeping the government open and paying its bills,
while bipartisan agreement on what day of the week it is, let alone
on further financial reform, cannot be guaranteed. But the question
of what to do about huge, complex, and seemingly hard-to-control
universal banks that benefit from implicit state support remains
unresolved.
The "school solution," agreed at the Financial Stability Board in
Basel, is that global regulators should clearly identify
systemically significant banks and impose tougher regulations on
them, with more intensive supervision and higher capital ratios.
That has been done.
Initially, 29 such banks were designated, together with a few
insurers - none of which like the company that they are obliged to
keep! There is a procedure for promotion and relegation, like in
national football leagues, so the number fluctuates periodically.
Banks on the list must keep higher reserves, and maintain more
liquidity, reflecting their status as systemically important
institutions. They must also prepare what are colloquially known as
"living wills," which explain how they would be wound down in a
crisis - ideally without taxpayer support.
But, while all major countries are signed up to this approach, many
of them think that more is needed. The US now has its Volcker rule
(though disputes between banks and regulators about just how to
define it continue). Elsewhere, more intrusive rules are being
implemented, or are under consideration.
In the United Kingdom, the government created the Vickers
Commission to recommend a solution. Its members proposed that
universal banks be obliged to set up ring-fenced retail-banking
subsidiaries with a much higher share of equity capital. Only the
retail subsidiaries would be permitted to rely on the central bank
for lender-of-last-resort support.
A version of the Vickers Commission's recommendations, which is
somewhat more flexible than its members proposed, is in a banking
bill currently before Parliament. A number of MPs want to impose
tighter restrictions, and it is difficult to find anyone who will
speak up for the banks, so some form of the bill is likely to pass,
and big British banks will have to divide their operations and
their capital.
The UK has decided to take action before any Europe-wide solution
is agreed. We British are still members of the European Union (at
least for the time being), but sometimes our politicians forget
that. Sometimes they simply lose patience with the difficulty of
agreeing on changes in negotiations that involve 28 countries,
which seems especially true of financial reform, given that many of
these countries are not home to systemically important banks and
probably never will be.
But EU institutions have not been entirely inactive. The European
Commission asked an eminent-persons group, chaired by Erkki
Liikanen, the head of the Finnish central bank, to examine this
issue on a European scale.
The group's report, published in October 2012, came to a similar
conclusion as the Vickers Commission concerning the danger of
brigading retail and investment banking activities in the same
legal entity, and recommended separating the two. The proposal
mirrors the UK plan - the investment-banking and trading arms, not
the retail side, would be ring-fenced - but the end point would be
quite similar.
But the European Banking Federation has dug in its heels,
describing the recommendations as "completely unnecessary." The
European Commission asked for comments, and its formal position is
that it is considering them along with the reports.
That consideration may take some time; indeed, it may never end.
Germany's government seems to have little appetite for breaking up
Deutsche Bank, and the French have taken a leaf from the British
book and implemented their own reform. The French plan looks more
like a Gallic version of the Volcker rule than Vickers "à la
française." It is far less rigorous than the banks feared, given
President François Hollande's fiery rhetoric in his electoral
campaign last year, in which he anathematized the financial sector
as the true "enemy."
So we now have a global plan, of sorts, supplemented by various
home-grown solutions in the US, the UK, and France, with the
possibility of a European plan that would also differ from the
others. In testimony to the UK Parliament, Volcker gently observed
that "Internationalizing some of the basic regulations [would make]
a level playing field. It is obviously not ideal that the US has
the Volcker rule and [the UK has] Vickers..."
He was surely right, but "too big to fail" is another area in which
the initial post-crisis enthusiasm for global solutions has failed.
The unfortunate result is an uneven playing field, with incentives
for banks to relocate operations, whether geographically or in
terms of legal entities. That is not the outcome that the G-20 - or
anyone else - sought back in 2009.
Copyrights: Project Syndicate