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The Actuary The magazine of the Institute & Faculty of Actuaries

ICB banking proposals fall short on governance issues

The ICB recommendations stopped short of proposing a full separation of companies' retail and wholesale banking activities (The Actuary, 12 September), but author of the report, NIESR director Dr Angus Armstrong believes that ring-fencing is not enough.

"Deeper and more fundamental reforms of the governance of banking and funding markets are required," he said.

Dr Armstrong argues that the ICB's recommendations place too much faith on regulators and regulations - some of which may not be operational in the "fog of war". He says that there will only be a real reduction in excessive risk-taking when the personal incentives of those in the industry to take excessive risk are reduced. This requires a fundamental reassessment of the formal and informal institutional environment - corporate ownership and governance, the structure of markets, and even ethical standards.

Dr Armstrong's NIESR report also includes the following observations:

‘Moral hazard was at the core of the crisis. But there is a distinction between whether this is caused by executives and shareholders knowing that they are personally immune from heavy losses and whether, in particular, they expect governments to support failing institutions. If the former is the case, which we suspect, then changing the ownership structure of banks and legal responsibilities of executives is necessary.

‘The ICB report largely ignores the role of shadow banking, which was to a large extent the proximate cause the crisis. Indeed there is a risk that tighter regulations on capital and liquidity will have perverse effects, and lead to the further migration of lending beyond the regulatory perimeter, to the shadow banking system.

‘The ICB's reliance on competition to improve bank behaviour in both retail and wholesale markets is excessive. Given the informational asymmetries in key funding markets, and way in which the failure of those markets propagated contagion, it is essential that regulators do not simply apply a naive view that competition alone will lead to optimal outcomes but rather consider the public good aspect of well-functioning funding markets.'