The writer is a founding partner of Veritum Partners
The UK’s move to relax some of the so called ringfencing restrictions on the banking sector as part of wider ‘Big Bang 2.0” reforms after Brexit is a case of too little, too late.
The move is welcome but if the UK really wants its liberalisation to be both big and to have a bang, it should simply abandon the ringfence.
The ringfence was the brainchild of proposals made by the Independent Commission on Banking (ICB) over a decade ago in the wake of the 2007-2008 financial crisis, where the UK suffered the largest global bailout of any banking sector.
That change was needed was without dispute — the risks of bank failure and taxpayer bailout had to be reduced. The commission had two main recommendations; that banks needed more capital to absorb losses and that there was the need for structural reform to make it easier to resolve problems when banks get into trouble. On both counts, today’s ringfence has become irrelevant.
On capital, the ICB’s recommendation was that banks increase their capital ratios to 10 per cent. Today, with large UK banks enjoying capital ratios nearly 50 per cent higher than those recommended levels, it is clear that the risk of failure is much lower than even the commission was recommending.
The second aspect — structural reform — has similarly become irrelevant. The idea of ringfencing was to separate the more dangerous “casino” banking operations (investment banking) from the “safer” retail banking, so that losses in investment banking would not threaten the viability of the retail banking. Yet over the past decade banks have created “resolution regimes” which are effectively a rule book governing how they would fail, but in an orderly way that would result in their key functions continuing. In effect, a better way than ringfencing to deal with the risk posed of losing money at the casino.
Indeed, a government commissioned Independent Review of ringfencing earlier this year similarly concluded: “The ringfencing regime was an earlier attempt at addressing too-big-to-fail with a focus on a narrow set of critical functions. But it is the resolution regime that is now overtaking ringfencing in providing a more comprehensive solution for tackling this issue.”
The suggestion that ringfencing should be relaxed for a few smaller banks yet kept in place for all larger banks does not go far enough in addressing what has become a serious impediment for larger UK banks.
Some might argue ringfencing is not doing any damage and, given the costs to taxpayers of the 2007/2008 bailouts, it’s fine to have a belt and braces approach. Except it’s not.
First, ringfencing itself has created an illusion of safety that to some extent has meant banks and regulators have focused less on creating the more important resolution regime. Indeed, the Bank of England has warned that ‘if a big UK bank fails, the option created by ringfencing to carve out the ring fenced bank [and placing the rest of the bank] into insolvency, would not be a viable option’.
Second, ringfencing creates risks. By splitting banks in two, the diversification benefits of having businesses with profit cycles dovetailing together are effectively lost. Indeed, arguably the risks are greater in standalone safer retail banks than in investment banking. RBS and HBOS suffered £21bn of trading losses at the “casino” in the late 2000s financial crisis, yet that was dwarfed by the £70bn they lost from their traditional lending business.
And finally, ringfencing costs money. The Independent Review estimated there was a one off cost of just under £3bn and annual costs of £1.5bn. Be under no illusion — these costs are indirectly passed on to customers.
If the UK government is serious about wanting to improve the competitiveness of the UK banking system as part of its post Brexit liberalisation agenda rather than tinkering, the ringfencing regime should simply be abandoned. Indeed, the government might reflect on why it is the case that no other country followed the UK in creating the ringfencing regime in the first place.