Promotion of Financial Stability through Structural Regulatory Reforms: Revisiting the Separation of Retail and Investment Banking and Consequences for the Hedge Fund Industry

Abstract

The independent Commission on Banking has submitted its Final Report. It contains recommendations for new financial regulation. Primarily these recommendations are for banking regulation within a broader financial sector. Essentially the report focuses on two aspects of banking; those are Financial Stability and competition. The financial stability deals with structural changes or in other words structural regulation. The Commission has recommended structural changes to the existing financial regulatory regime whereby it has proposed the separation of retail banking and investment banking, the purpose of which is to achieve financial stability. The Commission has recommended to ring-fence the retail banking which will include vital banking activities; these are identified as mandatory services which a retail bank must provide and on the other hand the report also specifies the prohibited activities for the ring fenced bank which it must not offer, this includes services to financial companies. Thus, a hedge fund company (HFC) being a financial company falls outside the ring-fence, therefore, it will not be provide vital banking services, because a ring-fenced bank is prohibited to provide these services in this context. It concludes that it is unfair to HFCs that being SMEs they are denied these services. There is no evidence that a HFC could be a threat to 'financial stability' of the system, rather it supports economy which would contribute to the 'financial stability' of the very system, which is the purpose of the recommendations. At the outset this discussion is supported by the discussion of the generic concepts financial stability, banking services, financial system and the separation of retail and investment banking.