Independent Commission on Banking
In its final report, published on 12 September 2011, the Independent Commission on Banking proposed radical changes to the way banks authorised in the UK structure themselves and manage their retail banking activities. If fully implemented, these recommendations will have a fundamental impact on the UK domestic banking market and UK universal banks’ role in global investment banking markets.
The recommendations, along with the European Capital Requirements Regulation, higher capital requirements for trading activities and the G20’s agenda for OTC derivatives will lead many midsized and most large banks to reassess what business they take on, their growth strategy, capital structure and legal entity arrangements.
The ICB’s key proposals
UK retail ring-fencing
The ICB concluded that the best way to prevent another financial crisis was to separate retail banking operations from investment/wholesale banking functions, effectively creating a ring-fence around personal and SME deposits and overdrafts. The aim is to provide continuity of service to those more vulnerable customers, while allowing the banking group’s activities outside the ring-fence to fail in an orderly fashion.
Under the recommendations, the largest ring-fenced UK retail banks will be required to hold equity capital equivalent to 10% of their risk-weighted assets (RWAs). They will also have to hold capital equivalent to an additional 7-10% of RWAs in the form of primary loss-absorbing capital.
Bail-in and depositor preference
The report recommends that the UK resolution authority should have a statutory power of bail-in (to recapitalise banks in resolution) and that insured deposits should have preferred creditor status.
The ICB called for improved processes for customers to switch accounts and greater transparency so that customers can compare prices. The proposals may also create opportunities for non-UK banks to compete in the British retail banking market and could inhibit UK investment banking operations in competing globally.
Under ring-fencing, banks will be required to create separate standalone subsidiaries with their own governance arrangements. There will be limits on their financial and operational links with investment or wholesale banking entities in the wider group. The ICB has allowed flexibility over the positioning of other activities such as the corporate loan book.
Challenges and imperatives
Our strong working assumption is that the Government, the Bank of England and the Financial Services Authority/Prudential Regulation Authority will implement the ICB's report more or less in full, provided they are not restricted by EU Regulations. There is still uncertainty about the details of the Government’s response and, in particular, the design of the ring fence.
The ICB’s recommendations are also part of a wider regulatory response to the financial crisis, and the relative impact on UK banks depends on the reaction of regulators elsewhere. However, institutions should begin high-level planning and strategic thinking on the ICB’s proposals now:
- The ICB's proposals will have a material impact on some banks' strategies. Sufficient significant detail is already available to allow institutions to identify probable results and narrow their options.
- Working through and beginning to quantify these impacts to discuss possible outcomes internally is essential.
- Although the implementation timetable stretches to 2019, the ICB has urged banks and the Government to initiate the ring-fence as soon as possible. The market will also price in expectations well ahead of the deadline. It is possible to construct and position the ring-fence as a vehicle or legal entity well before knowing precisely which of the permitted activities it will contain.
- To the extent that the ICB causes banks to rethink strategic plans, there may be commercial advantage in being an early mover.