The Bankwatch

Tracking the consumer evolution of financial services

First Look – UK Independent Commission on Banking report has a focus on new competition, but implementation will have practical difficulties

Executive Summary pdf 8 pages 0.4MB


Full Report pdf 214 pages 2.2 MB

The report begins by summarising the impacts of the financial crisis on the UK banks.

Table of Contents here

The overall impact is summarised here:

Despite recent de-leveraging, the total balance sheet of UK banks is more than four times annual GDP. More than 80% of RBS and more than 40% of Lloyds are in state ownership. Competition in UK banking has been seriously weakened as rivals to the largest retail banks have left the market or been absorbed into others.

The general approach has three objectives

Making the banking system safer requires a combined approach that:

  • makes banks better able to absorb losses;
  • makes it easier and less costly to sort out banks that still get into trouble; and
  • curbs incentives for excessive risk taking.

Too big to fail:

Banks ought to face market disciplines without any prospect of taxpayer support, but systemically important banks have had and still enjoy some degree of implicit government guarantee. This is the ‘too big to fail’ problem. Unless contained, it gives the banks concerned an unwarranted competitive advantage over other institutions, and will encourage too much risk taking once market conditions normalise. It also puts the UK’s public finances at further risk, especially given the size of the banks in relation to the UK economy.

On the ability to withstand shocks:

Banks must have greater loss-absorbing capacity and/or simpler and safer structures. … The Commission, however, believes that the most effective approach is likely to be a complementary combination of more moderate measures towards loss-absorbency and structure.

While Basel 3 suggests a minimum capital ratio of 7% the Commission suggests 10%.

In the Commission’s view, the available evidence and analysis suggests that all such banks should hold equity of at least 10%, together with genuinely loss-absorbent debt. That would strike a better balance between increasing the cost of lending and reducing the frequency and/or impact of financial crises.

And on the topic of international banks the Commission is sympathetic to the need to remain competitive;

Subject to that safeguard for UK retail banking, and recognising that wholesale and investment banking markets are international, the Commission believes that the capital standards applying to the wholesale and investment banking businesses of UK banks need not exceed international standards provided that those businesses have credible resolution plans (including effective loss-absorbing debt) so that they can fail without risk to the UK taxpayer.

And the first novel suggestion to rank depositors ahead of other unsecured creditors in a wind-down situation.

Loss-absorbency and stability might also be improved by ranking the claims of ordinary depositors higher than those of other unsecured creditors.

But the key question was how they would treat investment vs retail banking, and indeed as predicted they will not propose break ups, rather ‘ringfencing’  those parts of large banks.  This is an important paragraph, which leaves questions as to how it might work in reality.  (emphasis mine)

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. Vital retail operations could be kept running while commercial solutions – reorganisation 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, 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.

The report notes that retail and wholesale/investment banking can be distinguished, which is interested, since Martin Wolf who is on the Commission has been quoted as noting this is not feasible.

Separation between retail banking and wholesale and investment banking could take various forms, depending on where and how sharply the line is drawn. While mindful of regulatory arbitrage possibilities at the boundary, the Commission believes that there are practicable ways of distinguishing between retail banking and wholesale and investment banking.

For the most part, retail customers have no effective alternatives to their banks for vital financial services; hence the imperative to avert disruption to the system for their continuous provision. Customers of wholesale and investment banking services, on the other hand, generally have greater choice and capacity to look after themselves.

The Commission recognises the ultimate firewall would be to separate the types of banking into separate structures, however it notes the benefits of universal banking would be lost.  It is not clear what that means, and I will leave that for later analysis.  However it will require overall capital and loss-absorbing debt rules for universal banks, as well as for the sub division retail bank.  This will make for interesting reporting and also for definition of the rules between reporting periods.

The Commission is therefore considering forms of retail ring-fencing under which retail banking operations would be carried out by a separate subsidiary within a wider group. This would require universal banks to maintain minimum capital ratios and loss-absorbing debt (as indicated above) for their UK retail banking operations, as well as for their businesses as a whole. Subject to that, the banks could transfer capital between their UK retail and other banking activities.

The report then goes on to discuss improvements to competition.  One proposal in particular will drive bankers nuts.  They note that Lloyds has 30% of all UK current accounts.  So they are proposing a ‘quick switch’ methodology be provided within a reasonable timescale.

This Interim Report suggests that it may be possible to introduce greatly improved means of switching at reasonable cost, in which case the industry should be required to do this within a short timescale, and that barriers to entry may be able to be reduced.

Relevance to Bankwatch:

I got this summary from their length Executive Summary which reads more like a report, because I wanted to get an overview.  Now I have a better idea of what they are suggesting, I will dig into the main report, and have a better idea what I am looking for.

Meantime a couple of items to note;

  1. Ringfencing will be a bureaucratic reporting nightmare
  2. The quick switch idea to move accounts to a different institution is a non-starter in my view
  3. UK banks will be safer as a result of the increased capital requirements but so what – they are already nationalised.  Where is the direction to un-nationalise them.  That is what I am looking for.




Written by Colin Henderson

April 11, 2011 at 09:39

Posted in regulation, UK

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  1. […] EDIT 11th April, 2011:  Interim report issues 11th April – for my first look click here […]

  2. […] Commission of Banking or here on my blog Beyond improvements to the existing system, full account number portability would enable customers […]

  3. […] EDIT 11th April, 2011:  Interim report issued 11th April – for my first look click here […]

  4. […] Commission of Banking or here on my blog Beyond improvements to the existing system, full account number portability would enable customers […]

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