UK financial regulation architects warn against scrapping ‘ringfencing’

Two architects of the UK’s post-crisis financial regulation have warned against the “reckless” abandonment of rules forcing the separation of big banks’ retail and trading divisions, after an independent panel suggested “ringfencing” could be replaced by measures ensuring banks can fail safely.

The Treasury-commissioned Skeoch report said last week that the three-year-old ringfencing regime designed to protect savers’ money from trading blow-ups should be retained for now. But it also argued for the potential exclusion of some banks on the basis that they were “resolvable”, a term that means they could fail with minimal public harm.

The report said that, in the longer term, measures to ensure banks are resolvable should play a “more prominent role” than ringfencing, paving the way for the costly separation of banks’ operations to be abandoned in favour of newer measures that protect taxpayers through provisions such as the forced conversion of some bonds to equity, a process known as “bail in”.

A UK Treasury and Bank of England task force will now consider the recommendations on the future of the regime for banks with more than £25bn in deposits, a group that currently includes HSBC, Barclays, Lloyds, NatWest Group, Santander, Virgin Money and TSB.

“If anybody in the world believes bail in will work, it is me,” said Sir Paul Tucker, a senior fellow at Harvard University who was Bank of England deputy governor from 2009 to 2013 and chaired the G20 group that designed the bail in package. “But it would be reckless for Britain to put all its chips on that until bail in has worked in a massive live case, not just in desktop exercises, and even then I’d keep it just in case. Ringfencing helps protect citizens from banking Armageddon.”

Sir John Vickers, who led the 2011 report that spawned ringfencing, said the Skeoch report’s apparent treatment of “resolution” as an alternative to ringfencing was “puzzling”. Keith Skeoch and his fellow experts suggested a bank could be excluded from ringfencing if the Treasury and regulators judged that it could be “resolved” with minimal fallout and that its resilience would not be harmed by integrating its trading and retail businesses.

“If a bank is big and complicated enough to be in the regime, it seems not plausible that it could be resolved just like that. If the threshold is never going to be met [for exclusion], why have the power?” said Vickers, adding that ringfencing improved banks’ resolvability since they were already neatly divided into distinct parts.

More generally, Vickers — who is now economics professor at All Souls College, Oxford — said minimising the harm of bank failures was “just one of several reasons we went for ringfencing” in 2011. Post-crisis regulators also wanted to detach the freewheeling culture of trading divisions from retail banking, which they believed demanded a more sedate approach, and to impose separate governance structures for businesses that are inherently different.

It has been a costly and painful journey for the UK banking industry. HSBC alone spent £1.5bn on severing the governance, funding and operations of its UK retail bank from the rest of its business. Smaller banks, including Goldman Sachs’ Marcus, have argued that the regime effectively imposes a £25bn cap on their deposits since the cost of doing business increases massively once that threshold is crossed.

A spokesperson for the Skeoch panel said “the ringfencing regime is worth retaining at present but needs to be more adaptable to better serve customers and address future risks” and needed to be better aligned with resolution.

“Over time, the distance that is developing between the ringfencing and resolution regimes is likely to grow,” the spokesperson said, adding that the resolution regime “is now overtaking ringfencing in providing a more comprehensive solution” for making sure banks can fail safely.

The Treasury said: “We welcome the independent panel’s comprehensive set of recommendations and will establish a task force with the Bank of England to assess the options recommended by the panel and will publish a government response later this year.”