Ringfencing banks

Jacqui Hatfield picks through the ICB report and its implications for the banking sector


George Osborne
George Osborne

The long-awaited final Independent Commission on Banking (ICB) report has been published. 

The interim report, published in April, was controversial because it advocated ringfencing between retail and investment banking and proposed that retail banks should hold more capital than required under Basel III.

There will be a general sigh of relief amongst the large UK banks that the ringfencing will not be a total separation. Retail banking will need to be carried out in a separate subsidiary to investment banking with an independent board and separate capital requirements, but both subsidiaries can be held by a common parent holding company.  

The ringfencing requirement is much less clear cut than expected, giving the banks some flexibility to decide what is inside and outside the ringfence. It is helpful that they have until 2019 to implement the structural changes.

Despite the flexibility, it is important that ringfencing does not make the UK uncompetitive against our global peers. The structural changes will in themselves be costly for banks to implement and wholesale funding to investment banking divisions will also be costly. 

When the issue of ringfencing was first raised, Chancellor of the Exchequer George Osborne said initially that he supported the idea, but would not do so alone. He was undoubtedly thinking of competition aspects at the time. However, despite this, he has backed the proposals.

There are issues as to whether a requirement for retail banks to be subsidiaries is compatible with the Rome Treaty. More work will need to be done on this aspect of the report to ensure that the ultimate changes imposed domestically in the UK can sit alongside EU requirements. Such a structural change must be impacted by EU legislation. 

In respect of the international market, there are a number of international branches operating retail banking services in the UK and they may consider moving those services if they are required to convert their branches to subsidiaries. Some banks, for example, look at moving their entire operations abroad in the interim. In addition, there is a danger that some banks may be tempted to permanently move their head offices abroad rather than comply with ringfencing. 

The requirement for retail banks to hold 10 per cent core equity against their assets, when Basel III reforms require 7 per cent, is notable. In order for global reform to work, it needs to be uniformly implemented. 

Ringfencing should assist with the too-big-to fail issue, although the majority of a bank’s activities are likely to fall within the retail ringfence. It should be remembered that the banks which required the most government support would have fallen within the retail ring fence and ringfencing would not have changed the outcome in respect of these banks.

Good corporate governance is key to risk management. Corporate governance was not addressed sufficiently in the interim report and neither is it addressed sufficiently in the final report.

Jacqui Hatfield is a partner and head of the financial services advisory group at Reed Smith