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Banks should return to single capacity

It's been over twenty years since "Big Bang" in the UK where single capacity business was abolished in favour of duel capacity. Single capacity was where brokers could only deal on behalf of clients earning commission and duel capacity is where brokers can deal for clients but also themselves.

The fear was always that brokers could be compromising the best interests of their clients for their own corporate benefit. So of course many rules were introduced to preserve the client position and ensure that their assets were segregated from the principal position of the broker. Big Bang also brought the banks into the securities market and they gobbled up all the family owned Stock Exchange firms. Thus it was the banks that held sway and of course inherited the new duel capacity status. This increased significantly the pot on the table for the traders and subsequently the business evolved into the position it is today.

Big banks, loads of money and with lines diminishing between client assets and the willingness of the banks to compete with each other, escalated the stakes and drove the ongoing creation of more and more exotic financial instruments to increase their client's investments. The problem was that the derivative instruments now joined by a burgeoning hedge fund business were effectively writing naked short positions. The short positions were being continually overlaid by various other trades and instruments that spread across the markets and around the world. The collateral underpinning the global arbitrage business was being diluted as each new strategy built upon the previous. This type of business grew over a decade and more and would probably have continued for a while longer except for the property market crash in the US.

It's an interesting hypothesis that if ‘Big Bang' had not happened and Glass Steagall Act (GSA) in the USA had not been repealed would the financial crisis have gotten to its current level?

The segregation of retail and principal business provided under single capacity would have automatically protected the majority of investors and share savers/borrowers at the banks. The restriction of retail banks from using their capital and risking their customer's assets would have prevented nearly all the banks getting into trouble restricting the problem to those banks that had undertaken all the risks associated with derivative strategies.

Of course it's not possible to jog backwards and we are where we are today but as we analyse the market structure to try to prevent any reoccurrence of this disaster perhaps we should re-examine the market structure of old and the value and protection that single capacity provided.      

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Gary Wright

Gary Wright

Analyst

BISS Research

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19 Sep 2007

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London

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This post is from a series of posts in the group:

SEPA and European Payments

The Single Euro Payments Area, the Payments Services Directive, the Eurosystem, TARGET2, STEP2, the Euro and related matters.


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