Answer: when its financial structure is exactly like a bank.
A great piece by Jonathan Ford in today’s FT. For those on the wrong side of the paywall, Ford first points out that the troubled LC&F was economically just like a bank.
LC&F had, after all, many of the characteristics you’d normally associate with a banking institution. Here was a business that borrowed from its customers, promising to pay them both a fixed income and return their capital at par. The money wasn’t used to fund its own commercial activities, but lent out to other businesses. And if that weren’t sufficient, LC&F was also involved in so-called “maturity transformation”, meaning the risky game of borrowing money on shorter timeframes than it lent the stuff out. In short, you’d think: a bank.
Right. But the rules imposed by the regulators did not capture the fact that it was economically a bank, because (typically) the rules ignore the economic substance and focus on the legal form. LC&F issued bonds to investors with maturity of more than one year, which meant they weren’t regarded as ‘deposits’. Ford notes that LC&F could still have been classified as a “dealer in investments as principal” (an investment bank), but because the only bonds LC&F was a dealer in were its own paper, UK law let them off the hook. Thus
an entity running a banking book worth hundreds of millions had no banking licence or supervision, and subscribed equity capital of a piffling £50,000. Would the directors have passed the more stringent requirements of the senior management regime? We’ll never know.
As he concludes, “confidence in the system surely depends on those whose activities have the economic substance of banking being caught in its regulatory net”.
Right again.