UK Banking Set For Radical Shake-Up
Tuesday, September 13, 2011

The UK's banking sector is set for a major shakeup, as the Independent Banking Commission announces plans for a far-reaching ring fence in a report endorsed by the government.

After more than a year of research and deliberation, the Commission, headed up by Sir John Vickers, released its report on September 12. According to the report's Executive Summary, the aim is to create a more stable and competitive basis for UK banking in the longer term. This goal means that there needs to be greater resilience against future financial crises and the removal of risks from banks to the public finances. The UK also needs an effective and efficient system, with vigorous competition, the report argues.

In addition, the reforms are designed to safeguard and even improve the UK's competitiveness, with the report stating that these goals are "wholly consistent with maintaining the UK's strength as a pre-eminent centre for banking and finance, and are positive for the competitiveness of the UK economy".

The main thrust of the report is that the UK requires a system better designed to enable banks to absorb losses, reduce the cost of rectifying adverse situations, and curb incentives for risk taking. Three main sets of recommendations are made, based on three policy principles: retail ring-fence, loss absorbency, and competition. The concept of ring-fencing is perhaps the most contentious, as it would result in the isolation of the retail or 'high-street' section of a bank's activities from its investment sector, with the aim of insulating "vital" banking activities from problems in the financial system. This, the Commission hopes, would make it "easier to sort out both ring-fenced and non-ring-fenced banks which get into trouble", without calling in the taxpayer.

Setting up a ring-fence would also see such institutions prohibited from providing certain services. The report lays down a list of permissible activities, and also recommends the imposition of regulations on ring-fenced banks that are part of wider corporate groups, meaning that retail activities would have to be carried out in separate subsidiaries, "which would be legally, economically and operationally separate from the rest of the banking groups to which they belonged". The report suggests that domestic retail banking services should be inside the ring-fence, global wholesale/investment banking should be outside, and the provision of straightforward banking services to large domestic non-financial companies can be in or out.

Equity-to-risk-weighted-assets ratios would be stipulated, along with leverage ratios. Retail banking activities would have economic independence, and independent governance would be imposed to enforce the arm's length relationship.

The report is also clear that ring-fencing the banks is a more viable solution than the full separation of the retail and investment banking sectors. It argues that a ring-fence will guard against contagion risks, and that "the challenges of ring-fence design are manageable and not materially greater than those of full separation".

Addressing the crucial issue of competitiveness, the Commission argues that its recommendations will strengthen the UK's financial stability, which would, in turn, be good for the City of London's reputation. In addition, the capital standards suggested for the ring-fenced banks would be designed to safeguard the competitiveness of the retail sector. The report is clear that an early resolution of outstanding policy uncertainty would be beneficial, and stresses that banks out to be encouraged to implement changes at the earliest opportunity. Nonetheless, the deadline it puts forward is 2019, which offers "ample time" to minimise any transition risks.

The British Bankers' Association said that any further reform of the banking system must be carefully analysed and compared against internationally agreed reforms. It also emphasised that the full impact of such reforms on the economy, the recovery and banks' ability to support their customers in the UK must be understood. In spite of such a clear message from the banking industry, and fears that implementing the Commission's recommendations could lead to a flight of leading banks from the UK's shores, Chancellor George Osborne remains resolute that reforms must be introduced.

Speaking to the media in front of Number 11, Osborne said that the Commission had tackled the crucial issue faced by the UK, of how it can be "a home to successful banks that compete around the world and lend to British families and British businesses while at the same time protecting us as taxpayers from the cost of them going wrong and not ending up with a multi-billion pound bill when the bank collapses". Osborne added that the government had set up the Commission "to ask the questions that frankly should have been asked decades ago", and that, in his opinion, it had "done a very good job". He concluded, "the government will now get on with implementing the Vickers Report".