Paul Volcker: ring-fencing banks is not effective

Paul Volcker, American economist and founder of the ‘Volcker Rule’, has advised the UK that plans to force banks to ring-fence their traditional retail arms from "casino" investment divisions would not work in the event of a bail out.

In the US, the "Volcker Rule" advocates an outright ban on all forms of risky investment activity on the bank's own account, such as proprietary trading. The rule forms part of the Dodd-Frank act and it has drawn scathing remarks from banking bosses.

He claims that ring-fencing would only work in “fair weather” conditions, but would falter if banks were under pressure.

"In my experience ring-fencing is not terribly effective," said Mr Volcker. "It only works in fair-weather. They have already run into problems and they are bound to run into more."

The criticism comes less than a month after the publication of Sir John Vickers' banking reform proposal.

Following Sir John's recommendations, Britain's biggest banks will get until 2019 to implement ring-fencing reforms, which are hoped will protect taxpayers from having to bailout the system again.

The cost of ring-fencing is estimated to be between £4 billion and £7 billion, but many of its critics question whether it can adequately cordon off retail deposits.

"John [Vickers] and I have the same concerns in mind. But the logic would be to separate the two parts of banking, not to keep them within the same institution,” Mr. Volcker recommended.

Mr Volcker said that it was unclear how the two parts of banking could be entirely independent when under ring-fencing they would be subordinated to the holding company.

Last Friday, the Bank of England Governor Sir Mervyn King said that the Government had watered down the proposals after frantic lobbying from the industry. The Governor also expressed disappointment over the choice to ring-fence rather than opt for "total separation".