Regulators are splitting up retail banks from their larger investment banking and global operations. Retail banks are the providers of the services you would normally expect at a branch, online, or that a small business would use. The idea behind this split is to protect the essential parts of the business from the riskier investment side, and therefore make it less likely for average customers to be affected by any failures or volatility caused by the large banks investment arms.
Once in place, the new rules should make it easier for the Bank of England to let investment banking operations collapse while keeping the retail banks running, should a large bank face a major crash due to their investment branches.
The ring-fenced banks will need to shift their business model to make sure they are not too reliant on their investment bank for revenues, and they will have to have their own legal, HR and risk operations, separate from the investment banks. In addition, they will have to set up their own independent access to the payments systems and add substantial capital buffers. Together, these efforts should insulate the retail banks from wider problems and volatility in the financial markets.
In theory, this means the government will never have to bail out a lender with a big investment bank ever again, but we’ll have to see what actually happens come crunch time when he financial markets are panicking over the latest downturn.
This change will not be cheap to implement. One effect the average customer may feel comes from the fact that these banks will have to put aside tens of billions of pounds more in capital buffers, which could decrease the amount they lend out to ordinary consumers and businesses. On top of that, big banks will be spending an estimated £200m each to implement the reforms, and then £120m per year sustaining the extra staff in areas like IT, HR and risk. These extra costs could also be passed on to customers.
The rules are aimed at the biggest six lenders, namely HSBC, RBS, Lloyds, Santander UK, Barclays and the Co-operative Bank. Any challenger banks who climb above the £25bn deposit mark by 2019 will also need to preparing for these regulations.
The Bank of England has made it clear that there will be no relaxation of the incoming ring-fencing rules. However, in one minor concession, the retail banks will be able to pay dividends to their parents, as long as they tell the regulator first and show the payouts will not harm their resilience and stability.
Cross-selling is also still allowed, as long as it is carried out on commercial terms and the ring-fenced bank can still survive without those deals in place.
As Deloitte’s Clifford Smout explains,
Ring-fenced banks will have to become autonomous from the rest of their groups in a whole host of ways – from needing their own risk management resources, to re-engineering their relationships with financial market infrastructures (including the Bank of England itself), and disentangling the complex financial connections between different parts of the group. The requisite investments in systems, data capabilities and compliance architecture will be considerable.
There is a lot of detail to digest here, and industry faces a challenge to incorporate all this new information into revised – and ‘near final’ – implementation plans for the regulators in just three months.”
Ring-fenced banks will learn next year how much extra capital they will have to set aside in this ring-fenced unit.
The biggest banks are on track to hold a 7pc capital buffer, plus up to an additional 2.5pc to cover the risks they pose to the wider financial system. There is also the possibility of an additional 3pc to those buffers to account for the ring-fenced bank’s importance.
Regulators still need to assess the size of each bank’s loans based on how risky they are, then make the banks hold extra capital worth as much as 12.5pc of that value, to cover the bank in case the loans go bad.
The Bank of England has also stipulated the power to add another “counter-cyclical” buffer if it fears the economy is growing unsustainably quickly.
There are further conditions likely to be imposed by international regulators as they force big banks to get better at estimating the riskiness of their own lending.
These rules are supposed to come into full fruition in 2019.
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