UK Banking Faces Major Shake-Up
Friday, December 23, 2011

The UK's banking system will be fundamentally overhauled over the next ten years as the government plans to implement the Vickers Report's recommendations in full.

Publishing its response to the report by the Sir John Vickers-led Independent Commission on Banking (ICB), the government has said that it agrees with the recommendations. Vickers set out plans to fundamentally reform the structure of banking in the UK, which includes proposals for a far-reaching ring fence of banking activities. Following on from this, the government will legislate to create what it believes will be a stable banking sector that supports lending to businesses, and removes the implicit taxpayer guarantee in the event of a bank failure.

After more than a year of research and deliberation, the Commission released its report in September. It identified a need to make banks better able to absorb losses, to make it easier and less costly to sort out banks that still get into trouble, while curbing incentives for excessive risk-taking. In its response to the report, the government states that it agrees that structural reform of the banking sector is needed and supports the ring-fence proposals. The government also supports the proposal that any fence should be flexible in location but of sufficient height to ensure effective legal, operational and economic separation between entities.

The government intends to establish a set of mandated services within ring-fenced banks consisting of retail and SME deposits and overdrafts, and a set of wholesale and investment banking services to be prohibited from ring-fenced banks. In addition, the government believes ring-fenced banks should be allowed to conduct ancillary activities to support the provision of their core functions, and that they should be legally and operationally independent from the rest of their corporate group. The government also wants to see that, economically, the ring-fenced bank should not be dependent for their liquidity and solvency on the financial health of the rest of their group.

The reforms will also see higher equity requirements for large ring-fenced banks, and the government will seek sufficient flexibility in forthcoming European legislation to do so in the interests of UK and European financial stability. The government has voiced its strong support for a mandatory, minimum leverage ratio for all banks, and believes there may be a case for applying a higher minimum leverage ratio to some larger banks. It adheres to the principle that systemically important banks hold a minimum amount of loss-absorbing capacity on a group-wide basis, but that, if a bank can show that its non-UK operations do not pose a risk to UK financial stability and thus to the UK taxpayer, this requirement should not apply to those operations.

The ICB said that its recommendations should be fully in force by no later than the start of 2019, consistent with the deadline for implementation of the Basel III reforms agreed by G20 leaders. The government's intention is that implementation should proceed in stages with the final, non-structural, changes related to loss absorbency fully completed by the beginning of 2019.

Legislation relating to the ring fence will be completed by the time parliament dissolves in May, 2015. Banks will be expected to be compliant as soon as practically possible thereafter. The government will work with the banks to develop a reasonable transition timetable. The government will publish a White Paper next spring, setting out further detail on how the recommendations will be implemented, and has said that it is open to views on how to do so.

The Chancellor of the Exchequer, George Osborne, commented: “The Independent Commission on Banking was set up last year to look at what I have called the ‘British Dilemma’: how Britain can be home to one of the world’s leading financial centres without exposing British taxpayers to the massive costs of those banks failing. The government is preparing the most far reaching reforms of British banking in our modern history - our objective is to make sure what happened in Britain never happens again.”

The Secretary of State for Business, Innovation and Skills, Vince Cable, added: "Sir John Vickers has produced a comprehensive plan to give the UK a more stable banking system that removes the implicit taxpayer subsidy. We will take forward a full programme of reform with legislation in place to implement the ring-fence by 2015. The potential costs of an unsafe banking system are clear to everyone. Our reforms will protect taxpayers from the riskier aspects of banking and boost competition without harming the ability of UK banks to lend, to invest and to compete."

Commenting on the government's response, Jon Pain, UK head of financial services risk consulting at KPMG, said: “The face and structure of banking has changed for good and we’ve reached a point of no return. This will be remembered as a defining moment for banks in the UK and work will intensify as business models need to be fundamentally overhauled. Banks should not be fooled by the ICB timetable as major banks will need to make some serious decisions before June to submit their recovery and resolution plans (RRPs) to the relevant authorities, which could have major implications for their ICB thinking. UK global systemically important banks have six months to get their RRPs in order, or risk facing an additional capital resolution buffer both inside and outside the ring-fence.”

Angela Knight, head of the British Bankers' Association, defended the changes banks have already made. She said: "Today's banking announcement is not the start nor the end of a process: it is the next stage of a programme of reform which our banks have well underway. The main protections are already in place to ensure no British bank will ever again be considered too big to fail. All customers should enjoy complete confidence in the security of their accounts and the taxpayer should not foot the bill for failure. The UK's banks will work with the legislators and regulators to ensure customers' confidence and trust is fully restored in the UK banking system."

"The banks have already made significant changes to how they operate. They have built up capital far beyond the current requirements to ensure they can withstand any future financial difficulties. They have already accepted the principle of ring-fencing their retail and investment banking activities. The challenge now is to ensure this can be implemented while restoring financial stability, promoting economic recovery and ensuring regulatory reform meets the needs and expectations of all participants in the banking system - principally customers," Knight concluded.