IBC Recommends Ring-Fencing Of UK Retail Banking
Tuesday, April 12, 2011

The Interim Report of the United Kingdom’s Independent Commission on Banking (ICB), setting out its provisional views on possible reforms to improve stability and competition in UK banking, has suggested that the ring-fencing of retail banking activities could have several advantages.

“Beyond the immediate task of repairing bank balance sheets while restoring the normal flow of credit to the economy at large,” the IBC’s report says, “the challenge is to make the UK banking system more stable, and markets for banking services more competitive.” Those objectives, it adds, require a combined approach of making banks better able to absorb losses, making it easier and less costly to sort out banks that still get into trouble, and curbing incentives for excessive risk taking arising out of the ‘too big to fail’ problem.

In order that banks will have greater loss-absorbing capacity and/or simpler and safer structures in the future, the IBC believes that there should be a compromise between the “structural radicalism” of, for example, requiring retail banking and wholesale and investment banking to be in wholly separate firms, and a policy of not touching the banks’ structure while seeking to achieve stability by very high overall capital requirements.

The IBC believes that banks should hold more equity relative to their assets and, second, that creditors, not taxpayers, take losses if necessary. On equity capital, therefore, it considers the 7% baseline ratio of equity to risk-weighted assets in the Basel III agreement to be an important step, but that systemically important banks should hold equity of at least 10%, together with genuinely loss-absorbent debt. That, in its view, would strike a better balance between increasing the cost of lending and reducing the frequency and/or impact of financial crises.

With regard to the structural issues of loss-absorbing capacity, in the IBC’s preliminary opinion, ring-fencing a bank’s UK retail banking activities could have several advantages. “It would make it easier and less costly to sort out banks if they got into trouble, by allowing different parts of the bank to be treated in different ways,” it states. “Vital retail operations could be kept running while commercial solutions – reorganization or wind-down – were found for other operations.”

“It would help shield UK retail activities from risks arising elsewhere within the bank or wider system,” it adds, “while preserving the possibility that they could be saved by the rest of the bank. And in combination with higher capital standards it could curtail taxpayer exposure and thereby sharpen commercial disciplines on risk taking.”

It feels that retail customers have no effective alternatives to their banks for vital financial services, while customers of wholesale and investment banking services generally have greater choice and capacity to look after themselves. It is, however, “vital to find ways for the providers of these services to fail safely. Markets for wholesale and investment banking services – including their provision by ‘shadow banks’ – are also more international, as must be policy towards them, whereas national policies can bear more directly on retail banking.”

In fact, the IBC stresses that its approach is also designed with a view to UK competitiveness, and to the UK’s international obligations. In particular, it concludes, “so long as there are appropriate measures in place to protect UK retail banking, the IBC is not proposing that UK banks’ wholesale and investment banking activities should have to meet higher capital standards than are agreed internationally, provided that they can fail without risk to the taxpayer.”