November 13, 2012 / 8:06 PM / 5 years ago

UK bank reform plan slammed for moral hazard risk

LONDON (Reuters) - Britain’s plan to force banks to shield their retail operations from riskier activities could create a moral hazard from the expectation that lenders will be bailed out if they hit trouble, a top banker said on Monday.

Britain is forcing banks to safeguard, or “ring-fence,” their domestic retail operations to better protect taxpayers and depositors in case a bank’s investment banking and other trading activities run into problems.

“The language of ring fencing has huge risk of moral hazard,” said Stephen Hester, chief executive of Royal Bank of Scotland (RBS.L). “You are giving a charter in everyone’s minds for the next time there is a problem inside the ring fence, (the bank) gets bailed out by one mechanism or another.”

“I have a big worry about the moral hazard,” he told lawmakers as part of an inquiry into banking standards and industry reforms.

In the past the “vast majority” of banking problems have been in retail banking, he said.

“You are also letting a common currency that one part of financial services is more important than another. These are big mistakes,” Hester said, adding that authorities should be aiming for a system in which no part of a bank is bailed out.

Hester was parachuted into RBS after the bank neared collapse during the 2008 financial crisis and received a 45 billion pound bailout, which has left the UK taxpayer owning an 81 percent stake.

Peter Sands, chief executive of Asia-focused bank Standard Chartered (STAN.L), was critical of the concept that part of a bank could be shielded from trouble in another part.

“I am pretty skeptical of the benefits of ring-fencing. The notion that one bit of the group could get into trouble and the other bit would be unaffected is unlikely to hold. People would be very wary of how that worked,” he told the lawmakers.

In a submission to the inquiry, Standard Chartered said it had concerns that creating extra intra-group requirements will make banks “more brittle and unable to deal with relatively minor funding problems”.

    Many details of the reforms are still uncertain, and Hester, Sands and Lloyds Banking Group (LLOY.L) CEO Antonio Horta-Osorio expressed support for ring-fenced retail banks being able to offer “simple” derivative products to small companies.

    Sands told the commission it benefited banks, as well as customers, for borrowers to be protected against interest rate fluctuations, particularly in the current low interest rate environment.

    Britain’s biggest banks agreed earlier this year to compensate customers for past mis-selling of interest rate hedging products, after the financial regulator found evidence of “serious failings” in the way they were sold.

    Banks have been criticized for providing swaps which tied in customers for far longer than was necessary. Horta-Osorio said the duration of the products should not be different from the length of the loans they are sold against.

    “It makes sense that the derivative should be matched in duration to the underlying economic transaction,” Horta-Osorio said.

    Reporting by Steve Slater and Matt Scuffham; Editing by Leslie Adler

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