Investment banking must be firewalled

PARIS – Plans to improve banking regulation focus too much on bonus curbs and capital buffers, ignoring the need to divorce risky investment banking from the ‘very safe and boring’ business of commercial banking, an OECD official said.

The OECD’s Adrian Blundell-Wignall told Reuters that riskier banking businesses should pay the higher cost of capital for their activities, and not make inflated profits subsidised by cheaper funding from more conventional operations.G20 leaders meeting in Pittsburgh today and tomorrow are set to discuss capital requirements and limiting bankers’ bonuses, aiming to lessen the likelihood of another financial crisis.But Blundell-Wignall, who is deputy director of finance and enterprise affairs at the think tank, said that the faultlines of the system would remain if banks were not obliged to keep investment and commercial banking business separate.’What takes a (bank) company down is contagion risk. What is not being addressed is contagion risk. The only way to address that is through corporate structure,’ said Blundell-Wignall.’This is the staggering thing about the way the reform process is going. Nobody wants to do it because the banking lobby is just too strong,’ he said in a telephone interview conducted on Tuesday.The Organisation for Economic Co-operation and Development recommends such a change of corporate structure in a recently updated report on the financial crisis which was written primarily by Blundell-Wignal, a former banker.Tailoring capital requirements according to business line or activity was necessary, he said. But the surest way to curb the excessive risk-taking was to have straightforward separation of businesses so that each was identifiable for investors and had to pay the true cost of capital for that specific business.The OECD proposes using a non-operational holding company for distinct investment and commercial bank subsidiaries where bank groups are involved in both.That, said Blundell-Wignal, was the simplest way of making sure that riskier banking businesses were firewalled from the rest and made to pay the true, logically higher, cost of capital for their activities.’What we argue is get the cost of capital right so that you do not have investment banks which are making huge, inflated, subsidised profits, because they’re (now) paying the true cost of capital,’ he said. ‘If they’re not making as much profits they’re not paying as big bonuses.’Many policymakers are worried that the will to overhaul the financial system will wilt now that there are signs the economy is pulling out of recession.German Finance Minister Peer Steinbrueck said yesterday that Wall Street and the City of London were fighting hard against stricter regulation.Adair Turner, chairman of the UK Financial Services Authority, has said a hard and fast legal divide between narrow banking and investment banking was not a reasonable way forward.Another vital reform, Blundell-Wignall said, would be to have risk officers at all banks that have a seat on the board and report to the chairman rather than the chief executive.’Most banks really don’t like that (idea). But if the CEO employs the risk officer and the risk officer is not part of the board then you have nothing. Whether he has a job and takes money home to feed his family depends on the CEO.’- Nampa-Reuters