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The banks are laughing all the way to the……bank

Six years after the baking crisis broke the House of Commons is finally legislating to ensure it doesn’t happen again. It’s a joke if it wasn’t so desperately serious.

The Financial Services (Banking Reform) bill, which gets its second reading on Monday (11th), is implementing the Vickers proposals to ring-fence the retail segment of the banks whilst leaving their investment arms unprotected by taxpayer guarantee if they implode. But this is riddled with loopholes.

The Commons Banking Commission called on the ring-fence to be ‘electrified’, with penalties big enough to really deter the banks if they breached it, yet that is not being done. The new rules under the Basel III Agreement will not come into operation till 2019, fully 11 years after the great crash of 2008.

The City of London is expert at regulatory arbitrage and will get round the ring-fence with no trouble at all. Worst of all, nothing is being done about the other seriously damaging practices of current banking, particularly the shadow banking system (offshoring), over-concentration, bonuses, and derivatives.

Even before the ink is dry on the new banking bill, Wall street and the City of London, with provocative disregard for public concern about the urgent need for effective regulatory reform, are publicly advertising their latest wheeze to get round rules to make the derivatives market (estimated at $640 trillions, which was at the dark heart of the 2008-9 crash) less risky.

It is known in the trade as ‘collateral transformation’. Essentially the idea is that a company might approach a bank with a portfolio of lower-rated assets such as junk bonds, which the bank would then lend on to the repurchase (‘repo’) marketin exchange for government bonds or cash. The government bonds or cash can then be used by the original company as collateral to back their centrally cleared derivative trades.

There are clear connotations here of mediaeval alchemy. Some will see it, so soon after the sub-prime mortgage scandal nearly shipwrecked the entire global economy, as eerily reconstructing a similar device. The danger is that if it is a shadow group providing the financing who don’t understand the risk and who aren’t charging the right fee, it could once again insert more systemic risk into the financial system.

Once again the banking industry have contrived to get round regulations in a manner that makes where the risk really lies less transparent. That is exactly what precipitated the crash last time round.

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