Sir John Vickers' much-anticipated interim report on banking reform has outlined tentative plans to ring-fence banks' retail banking activities. The proposals have received a cautious welcome from the market, writes SIMON LOVEGROVE.
In June 2010, the UK Chancellor of the Exchequer announced the creation of an Independent Commission on Banking (the ICB), chaired by Sir John Vickers. The government’s brief to the ICB was that it would make recommendations covering:
structural measures to reform the banking system and promote stability and competition, including the complex issue of separating retail and wholesale/investment banking functions; and
related non-structural measures to promote stability and competition in banking for the benefit of consumers and businesses.
In September 2010, the ICB published a call for evidence which received a mixed response to the question of whether retail and wholesale/investment banking operations should be split. Whilst the ICB originally confirmed that it would publish its report in September 2011, it agreed at a meeting on 8 March that it would publish an interim report on 11 April 2011.
April's interim report was widely anticipated, but its public life began with a hitch asthe ICB’s website crashed under the heavy volume of hits during the morning of its publication. Working through the interim report’s 200-odd pages, the ICB’s proposals are fairly modest and can be summed up as follows:
the introduction, over time, of greater loss-absorbing capacity for systemically important banks comprising: an equity surcharge of at least 3% above Basel III requirements; additional loss absorbency provided by debt through bail-in mechanisms and possibly contingent capital; and some form of depositor preference.
Many in the market have cautiously welcomed the proposals on capital adequacy, arguing that they may not be too draconian on the basis that the UK banks have rebuilt their capital bases following the financial crisis and may already be close to meeting the higher requirements. It is also worth noting that the proposals may not make the UK stand out on its own, given that other national authorities (such as Switzerland) have called for higher capital buffers. What is interesting is that the calls from certain national regulators suggest that the capital requirements in Basel III may become the lowest common denominator. However, this is still far from certain and a lot depends on the course of action adopted by the larger markets, particularly the United States.
One of the key concerns regarding the operation of the ring-fence relates to overseas banks. The ICB states that the ring-fence is designed to fit within the EU legal framework, and that it is satisfied that it can be imposed on UK subsidiaries of foreign banks. However, the ICB notes that EU banks authorised in one member state (the home member state) have the ability to branch into another member state (host member state) using the home member state’s authorisation.
This clearly has the potential of putting UK authorised retail and universal banks at a competitive disadvantage against EU banks branching into the UK. The ICB states that in relation to capital this will depend to some extent on what the host member state regulators require their banks to hold; but its current view is that, in relation to retail banking, this constraint is only likely to arise at much higher capital levels than those contemplated in the interim report. In relation to structure the ICB argues that the costs of a ring-fence appear likely to accrue mainly or wholly on the wholesale/investment banking operations of universal banks. The ICB feels that it is far from clear that UK authorised retail banks would be at a significant disadvantage to retail or universal banks branching in.
The ICB also notes the possibility that existing UK retail banks could seek to avoid the ring-fence by transferring ownership of their UK business to an EU entity and then branching back into the UK. At present the ICB is unconvinced by assertions that such moves would be attempted on a large scale.
Another key issue is the practicality of the ring-fence. For example, banks rely on costs synergies and in terms of many central services such as IT wholesale/investment banking operations will not be easily separated from the retail banking operation. Furthermore, some commentators have questioned whether there can really be much expectation in terms of checks and balances, where the boards of the two entities are the same.
Whilst the interim report’s solution concerning the UK ring-fence and subsidiarisation is fairly clear, many questions still need to be answered. In particular, the practical issues relating to the provision of group services and living wills will need a lot of detailed thought. The decision not to go the whole way to require the splitting up of banks has been welcomed in some quarters, but the ICB’s halfway house will only succeed if it is workable and does not leave the UK at a competitive disadvantage globally. The jury is still out on this.
Simon Lovegrove is a lawyer with the financial services group at Norton Rose LLP