The PCBS regards the Government's approach to be too weak, particularly in the areas of:
- "Electrifying" the ring-fence;
- Allowing ring-fenced retail banks to sell derivatives;
- Allowing a ring-fenced retail bank to be a subsidiary of an investment bank; and
- Imposing a 3% minimum leverage ratio, in line with Basel 3; the PCBS would prefer a minimum leverage ratio of at least 4%.
The PCBS makes a number of recommendations to toughen the Banking Reform Bill. Even if the Government does not accept all of these recommendations, there remains the possibility that substantial cross-party support for the recommendations in both Houses of Parliament may be sufficient to introduce some of the recommendations as amendments to the Bill as it passes through Parliament for its second and third readings.
Implications for firms…
Banks with retail operations in the UK should be considering the potential impact of the PCBS recommendations:
- Scope – future reviews of the effectiveness of ring-fencing and its impact on competition could lead to a change in the size threshold at which ring-fencing becomes mandatory for a retail bank. The currently envisaged threshold of £25 billion of retail deposits might be lowered as a result;
- Electrification – the PCBS continues to press for periodic independent reviews of ring-fencing, so banks need to consider the possibility that full structural separation (not allowing retail banking within a banking group that also undertakes other banking activities) might be imposed as a result. This increases the uncertainty that the regime might be changed significantly in future years.
- Derivatives – the PCBS continues to want to impose a series of tests and safeguards on any selling of derivatives by a ring-fenced bank. This would make it more difficult and expensive for ring-fenced banks to provide risk management services to their customers;
- Group structure – the PCBS wants ring-fenced banks that are part of a wider banking group to be owned by a holding company, not by an investment bank;
- Link with recovery and resolution planning – banks may also face additional constraints on their organisational and operational structures as a result of other requirements imposed by supervisory and resolution authorities with the objective of constructing credible and effective recovery and resolution plans;
- Capital and loss absorbency – banks need to review the potential impact on their business model of at least a 4% minimum leverage ratio for ring-fenced banks. This could be a binding constraint on banks specialising in lending – such as mortgages – that carries a low risk weighting.
|For example, a bank with a balance sheet of £500 billion, tier 1 capital of £15 billion, and an average risk weight of 25% on its assets (so total weighted risk assets of £125 billion) would have a tier 1 capital ratio of 12% (capital/risk weighted assets) and a leverage ratio of 3% (capital/total assets).|
|Reaching a leverage ratio of 4% would require the bank to hold £20 billion of tier 1 capital (so a £5 billion (33%) increase in capital), or to reduce its balance sheet by £125 billion to £375 billion, or some combination of the two. This would increase the bank's tier 1 capital ratio to 16%.|
In the detail…
Predictably, the PCBS welcomes the areas where the Banking Reform Bill reflects its previous recommendations, but recommends a tougher approach where previous recommendations have been rejected by the Government.
The Banking Reform Bill already includes the first reserve power sought by the PCBS, namely the power of the regulator to break up a banking group that takes actions that conflict with the objectives of ring-fencing. However, the PCBS would like to see a more nuanced approach here, under which the regulator could also require a banking group to divest itself of a specific division or set of activities that would fall short of a full break-up.
The Government rejected the PCBS's earlier call for a second reserve power, under which a full separation of retail banking could be implemented across the banking sector as a whole, if this was decided by the Government and Parliament on the basis of an independent review. The PCBS continues to recommend that such a general reserve power be included in primary legislation.
The PCBS also recommends that periodic independent (ie. not by the regulator) reviews be undertaken to assess whether the objectives of ring-fencing are being met.
The PCBS would like to see the "continuity of the provision of core services" objective of the regulators being supplemented by objectives that focus more directly on the objectives of ring-fencing, namely the ability of banks to absorb losses, reducing the costs and difficulties of resolution, and curbing incentives for excessive risk-taking.
The PCBS continues to be nervous about the selling of derivatives by ring-fenced banks. They therefore continue to seek a "concise and enduring" narrow definition of simple derivatives, together with adequate safeguards including a cap on the value of derivatives that a ring-fenced bank could sell.
Threshold for ring-fencing
The PCBS wants to see competition and the impact on new entrants as a factor in the consideration of setting a de minimis threshold for ring-fencing (currently expected to be set at £25 billion of deposits).
The Bill currently allows for the possibility of a ring-fenced retail bank being owned by an investment bank. The PCBS would prefer to give the regulator a duty to require a ring-fenced bank to be owned by a holding company, and thus to create a "sibling" structure between retail and investment banks within the same banking group.
Capital and loss absorbency
The main PCBS recommendation here is for a higher minimum leverage ratio than the 3% contained in Basel 3. The PCBS would prefer a leverage ratio of at least 4%, adjustable in the light of annual assessments by the Bank of England of progress to improve the risk-weighting of banks' assets.
The Treasury has just issued some "illustrative" secondary legislation on ring-fencing. This covers only a limited set of issues, including:
- The definition of a "core" deposit from an individual or an SME that has to held within a ring-fenced bank;
- The threshold for a small or medium-sized enterprise – deposits from an SME are core deposits if the SME employs fewer than 50 staff and has a turnover of not more than £6.5 million or a balance sheet of not more than £3.26 million. This turnover figure sits between the £1 million figure used for deposit protection eligibility and the £29.5 million figure used in the Companies Act;
- The threshold of £25 billion of total core deposits, above which banks have to be ring-fenced;
- The basis on which deposits from high net worth individuals can be treated as core or non-core deposits;
- Allowing a ring-fenced bank to undertake transactions for its own risk management purposes;
- Allowing a ring-fenced bank to undertake simple derivatives with its account holders, up to an overall (but as yet unspecified) amount; and
- Restrictions on a ring-fenced banks transactions with other financial institutions.