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12th September 2011

Future of UK retail banking final report

The Independent Commission on Banking published its final report into the future of UK retail banking. The two big 'takeouts' for many will be the confirmation of retail bank ringfencing and the long introduction timescale allowed - up till 2019. There is a lot more to the report including governance proposals and ingenious solutions to certain aspects of the separation of retail from investment / corporate banking.

For those sitting on the fence as to whether the reforms are necessary or not an interesting statistic is that the UK banks combined balance sheet is equivalent to 4X annual GDP, with the inference that the UK taxpayer could be on the line for this total + any intervening growth should there be another banking crisis. The assets included in the new UK retail banking ring fence, therefore deemed necessary to save in a crisis would be between 16.66% & 33.3% of GDP.

The basic definition of retail banking is banking to individuals and SMEs within the European Economic Area excluding:

- financial service companies
- trading book activities
- secondary market activities
- purchase of loans and securities
- derivatives trading - "except as necessary for the retail bank prudently to manage its own risk" (!)

Retail banks will naturally be able to make and receive payments worldwide providing there is no liability connected with this of a speculative or trading nature.

What may ultimately be the most defining of its recommendations relates to governance. It recommends that the retail ring-fenced units have their own board headed by an independent chairman and with a majority non-executive members. The retail subsidiary be required to issue an annual report as if it were a separate listed company. The commission hopes that over time this will create a separate culture within the retail bank.

The capital requirements for the retail operation are very strict. The requirement is for equity capital of at least 10% of risk-weighted assets. In addition a further 7% capital in the form of Bail-In bonds or Contingent Capital (CoCos), plus the potential to require a further 3% of similar contingent capital. This compares with a 7.0% to 9.5% Core Tier 1 requirement under Basel III with the discussion on additional contingent capital still underway.

Some other highlights are:

- Financial Services Compensation Scheme should become a preferred creditor behind secured creditors but ahead of other secured creditors.

- The Commission remained concerned over whether the extent of the Lloyds sell off was sufficient for competition purposes. It suggested that total divestment should be around 6% of current account market share as opposed to 4.6% currently under the proposed 632 branch sell off. It was less precise as to how this be achieved and did not seem to wish to upset the current branch sale. In summary the commission suggested the government should "seek agreement with Lloyds Banking to ensure that the divestiture leads to the emergence of a strong challenger bank."

- The Commission recommends bank account switching to be completed within 7 days. That redirection of credits and debits be made possible. That charges and fees be more transparent. It has dropped its call for bank account number portability for the short to medium term accepting it is not currently practical.

- It believes the statement of the objectives for the new Financial Conduct Authority (FCA) be strengthened

- A decision as to whether retail banking is referred to the competition commission should be deferred until 2015 and a decision made on whether the following conditions were met:
a) Strong and efficient challenger be created from the Lloyds branch divestment

b) Ease of switching accounts significantly improved

c) FCA makes progress on better transparency and lower entry barriers

The report seeks to tackle the claim the changes are unaffordable with sections devoted to costing the recommendations, costing not acting and the benefits that may accrue. On capital it points out that the UK tax rules are generous towards debt financing (perhaps a hint to the government) making debt finance more cost effective than equity finance. It then goes on to argue the less the proportion of debt to equity finance the lower the risk and therefore the cost of the debt finance would reduce further. It also points out that the regime will gain / restore UK banking as a very safe banking location hence generating new business.

Perhaps one of the most interesting aspects of the report are its recommendations on government. It can be easy to overlook in preference to numbers, however could be the part that has the most significant long term impact. Whilst in some ways this almost seems to be separating banks completely into two the commission argues this is not the case. Retail and Investment arms can still work together to fulfil all of a client's needs. Surplus capital can flow in each direction. Premises, systems and to an extent even staff shared. In many respects if the Commission's vision is to be achieved then it will perhaps be even more important that the governance recommendations not be watered down than if the financial ones were.


Another thought from reading the report is that if the proposals are implemented this may give opportunities for smaller investment banks to expand and a new breed of lighter (and cheaper) investment banks to be formed, filling some of the vacated space. There are many mid-cap companies that could not afford the prices of the larger investment banks / Corporate Investment Banking arms.

The full report can be downloaded for free at:

http://bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf