134 Paul Volcker

risks and cultural issues involved. In the United States, there are restrictions on the activities of commercial banking organizations, particularly with respect to trading and links with commercial firms.

Financial institutions not undertaking on commercial banking activities will be able to continue a full range of trading and investment banking activities, even when affiliated with commercial firms. When deemed ‘systemically significant’, they will be subject to capital requirements and greater surveillance than in the past. However, there should be no presumption of official support – access to the Federal Reserve, to deposit insurance, or otherwise. Presumably, failure will be more likely than in the case of regulated commercial banking organizations protected by the official safety net. Therefore, it is important that the new resolution process be available and promptly brought into play.

The Independent Commission on Banking in the United Kingdom – the so-called Vickers Committee – recently proposed a more sweeping structural change for organizations engaged in commercial banking. In essence, within a single organization the range of ordinary banking operations – deposit taking, lending and payments – would be segregated in a ‘retail bank’. That bank will be overseen by its own independent board of directors and ‘ring fenced’ in a manner designed to greatly reduce relations with the rest of the organization.

Apparently, customers could deal with both parts of the organization, and some limited transactions permitted between them. But as I understand it, the ‘retail bank’ would be much more closely regulated, with relatively high capital and other stringent requirements. The emphasis is to insulate the bank from failures of the holding company and other affiliates. There seems to be at least a hint that public support may be available in time of crisis. That presumably would be ruled out for other affiliates of the institution.

I frankly have not absorbed all the practical and legal implications of the UK proposal. Surely, problems abound in trying to separate the fortunes of different parts of a single organization, reflected in the length and detail of the Commission’s Report (which may come to rival Dodd–Frank!). Perhaps most fundamentally, directors and managements of a holding company are ordinarily assumed to have responsibility to the stockholders for the capital, profits and stability of the whole organization, which does not fit easily with the concept that one subsidiary, the ‘retail bank’, must have a truly independent board of its own.

As an operational matter, some interaction between the retail and investment banks is contemplated in the interest of minimizing costs and facilitating full customer service. American experiences with ‘fire walls’ and prohibitions on transactions between a bank and its affiliates have not been entirely reassuring in practice. Ironically, the philosophy of US regulators has been to satisfy itself that a financial holding company and its non-bank affiliates should be a ‘source of strength’ to the commercial bank. That principle has not been highly effective in practice.

C© 2012 Blackwell Publishing Ltd.

Unfinished Business in Financial Reform 135

In any event, while there are differences in the structural approaches in the United States and United Kingdom, they are in fundamental agreement on the key importance of protecting traditional commercial banking from the risks and conflicts of proprietary activity. Both are consistent with developing a practical resolution authority. Widely agreed internationally, that will be the keystone in a stronger international financial system.

One thing for sure, we have passed beyond the stage in which we can rely on ad hoc responses in dealing with what have become increasingly frequent, complex and dangerous financial breakdowns. Structural change is necessary.

As it stands, the reform effort is incomplete. It needs fresh impetus. I challenge governments and central banks to take up the unfinished agenda.

Paul Volcker 610 Fifth Avenue Suite 420 New York, NY 10020 ankeDening@aol.com


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