Hand it to the UK. Under pressure from the wonks in Brussels – I suppose there is something to being ruled by unaccountable political science PhDs – the government has taken the first, halting steps toward breaking up three of its largest financial institutions:
The British government — spurred on by European regulators — is set to force the Royal Bank of Scotland, Lloyds Banking Group and Northern Rock to sell off parts of their operations. The Europeans are calling for more and smaller banks to increase competition and eliminate the threat posed by banks so large that they must be rescued by taxpayers, no matter how they conducted their business, in order to avoid damaging the global financial system.
A for effort, and as Simon Johnson quite optimistically suggests, perhaps this could nudge the Bernanke/Summers/Geithner crew to reconsider its determination to preserve the corporate forms of America’s major financials. But is this really the best way to go about it?
The UK is beginning with the banks in which it holds stakes, so to some level it can be thought of as an exercise in shareholder activism rather than regulatory force. HSBC and Barclays, not to mention all the foreign firms operating in the UK, are free to carry on as they were. I get it; you need to start somewhere, and you might as well start where there is consensus. A bit unfair to Lloyd’s, perhaps – they would not be in anything like their current condition if the government had not forced them to absorb HBOS – but that’s the price of striving for greatness.
The plan is a straightforward divestiture. RBS, Lloyd’s, and Northern Rock will need to sell branches to new entrants to the UK market – HSBC cannot simply buy them. When all is said and done, there will be one to three new large-scale banking operations in the UK. There is also talk about taking a page from Japan’s playbook – always a good strategy in consumer electronics and food, perhaps less inspired when it comes to finance – and merging one of the retail networks with the Post Office to give a more national footprint.
Let’s assume an auction goes according to plan, and the banks are not able to simply game the system by divesting all of their branches in Scotland and Wales. Suppose each new player is in each market.
The UK will have a much more competitive retail banking sector. Spreads will shrink, hours and service will improve. Actually, it’s the UK, so service will probably not improve, but the rest of the customer experience probably will. A bunch of money will be thrown at ad agencies, much to the relief of The Ivy and the coke dealers of Covent Garden.
What will not change is the financial sector’s vulnerability to shocks.
Think of the alternative – instead of creating two Mini-RBS clones, the government could separate the insurance and the banking operations of RBS. This would have a much smaller impact on the day-to-day behavior of the market for any given financial product. But it would ensure that a rash of property speculation only blew up the bank and left the insurance company alone, whereas in the Mini-RBS model, the last bubble would have blown up both smaller firms as surely as it hit the one larger one.
Reducing the size of the largest financial institutions is a good idea, and should gain some traction on this side of the Atlantic. But even more important would be reducing their scope. It’s a bigger regulatory challenge – you are not supervising the sale of real estate and deposits, but rather defining lines of business that successor companies will constantly challenge – but it is the one that will be the most pressing when the next bubble comes.