Government sets out plans to reform the structure of banking in the UK
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Issued 19 December 2011 - HM Treasury
The Government is today publishing its response to the report by the
Independent Commission on Banking (ICB), which sets out plans to
fundamentally reform the structure of banking in the UK. This response
agrees with the ICB’s recommendations and outlines how the Government
will legislate to create a stable banking sector that supports lending
to businesses and families, and removes the implicit taxpayer guarantee
in the event of a bank failure.
The Government will implement the ICB’s
advice in stages with the full package of reforms completed by 2019.
All necessary legislation will therefore be put in place by the end of
this Parliament. The Government will publish a White Paper in spring
2012 setting out further detail on how the recommendations will be
implemented; in advance of that, the Government is open to views on how
to implement these plans.
The Chancellor of the Exchequer, the Rt
Hon George Osborne, said:
“The Independent Commission on
Banking was set up last year to look at what I have called the ‘British
Dilemma’: how Britain can be home to one of the world’s leading
financial centres without exposing British taxpayers to the massive
costs of those banks failing.
The Government is preparing the
most far reaching reforms of British banking in our modern history -
our objective is to make sure what happened in Britain never happens
again.”
The Secretary of State for Business,
Innovation and Skills, the Rt Hon Dr Vince Cable, said:
"Sir John Vickers has produced a
comprehensive plan to give the UK a more stable banking system that
removes the implicit taxpayer subsidy. We will take forward a full
programme of reform with legislation in place to implement the
ring-fence by 2015.
"The potential costs of an unsafe
banking system are clear to everyone. Our reforms will protect
taxpayers from the riskier aspects of banking and boost competition
without harming the ability of UK banks to lend, to invest and to
compete."
Notes
1. On 16 June 2010, the Chancellor of the Exchequer and the
Secretary of State for Business announced the creation of the ICB, to
be chaired by Sir John Vickers. The Commission was asked to consider
structural and related non-structural reforms to the UK banking sector
to promote financial stability and competition, and to make
recommendations to the Government by the end of September 2011.
2. The ICB published its report on 12 September 2011, which can be
found here: http://bankingcommission.independent.gov.uk/
3. In welcoming the report, the Government committed to responding by
the end of 2011. The Government’s response can be found here: http://www.hm-treasury.gov.uk/fin_stability_regreform_icb.htm
4. Today’s response is open for comments until March 2012.
Executive Summary
In its final report the Independent Commission on Banking
(ICB) made recommendations to promote financial stability and
competition in UK banking. It recommended that its reforms be
implemented no later than the start of 2019.
Financial stability
On financial stability, the ICB identified three key
objectives:
* make banks better able to absorb losses;
* make it easier and less costly to sort out banks that still
get into trouble; and
* curb incentives for excessive risk-taking.
The ICB recommended a package of measures, consisting of
ring-fencing vital banking services and increasing banks’
loss-absorbency, to achieve these objectives. The Government strongly
supports these objectives and this dual approach.
Ring-fencing
On structural reform, the ICB recommended ring-fencing vital
banking services on which households and SMEs depend, keeping them
separate from wholesale and investment banking activities. This would
more effectively insulate them from problems elsewhere in the (global)
financial system and make banks easier to resolve without taxpayer
support. It would also curtail implicit government guarantees, reducing
the risk to the public finances and making it less likely that banks
will run excessive risks in the first place.
Improving resolvability of banks through structural reform is
in keeping with international initiatives to make it easier to deal
with failing banks. Structural complexity has been identified by the
Financial Stability Board (FSB) as one of the most important barriers
to successful bank resolution.1 And a consultation document on a
possible EU framework for bank recovery and resolution, published by
the European Commission earlier this year2, contemplated changes being
required to the structure of financial institutions, so as to reduce
complexity in order to allow critical functions to be separated off in
resolution.
The Government agrees with the ICB’s recommendation that vital
banking services – in particular, the taking of retail deposits –
should only be provided by ‘ring-fenced banks’, and that these banks
should be prohibited from undertaking certain investment banking
activities. The Government agrees that structural reform of the banking
sector is needed and supports the proposal for the creation of a
ring-fence around vital banking services.
The ICB set out a number of principles on which the ring-fence
should be based. For example the fence should be flexible in location
but of sufficient height to ensure effective legal, operational and
economic separation between entities. The Government supports all these
principles. Specifically, the Government intends that:
* There be a set of mandated services within ring-fenced banks
consisting of retail and SME deposits and overdrafts;
* A set of wholesale and investment banking services should be
prohibited from the ring-fenced bank in order to meet the objectives of
the policy;
* The ring-fenced bank should be allowed to conduct ancillary
activities to support the provision of its core functions;
* The ring-fenced bank should be legally and operationally
independent from the rest of its corporate group; and
* Economically the ring-fenced bank should not be dependent
for its liquidity and solvency on the financial health of the rest of
its group.
The ICB set out some further details to support these
principles. For example ring-fenced banks should be regulated for
capital and liquidity purposes on a solo basis, should not be
over-reliant on the rest of the corporate group for funding and should
undertake transactions with the rest of the group on a third party
basis. There is further detailed work to be done to translate the
principles into practice. More details on the ICB’s recommendations on
structural reform, and the Government’s plans for taking them forward,
are set out in Chapter 2. The ICB recognised that the case for de
minimis exemptions to the ring-fence restrictions was finely balanced,
but was not persuaded at the time. The Government’s view is that there
is a case for reviewing whether a de minimis exemption should apply.
Loss-absorbency
On increased loss-absorbency, the ICB recommended higher
equity requirements for large ring-fenced banks, a minimum leverage
ratio, loss-absorbing debt, insured depositor preference and higher
levels of loss-absorbing capacity for banks that are difficult to
resolve.
Many of these recommendations also fall within the range of
measures contemplated by internationally agreed reforms. The Basel III
rules clearly set minimum, not maximum, standards for equity and
leverage ratios. The FSB’s standards on resolution regimes require
national jurisdictions to make debt loss-absorbing in resolution
(‘bail-in’). And the European
Commission’s consultation document on a framework for bank recovery and
resolution contemplates both bail-in and requiring institutions that
are hard to resolve to hold more loss-absorbing debt.
The Government supports the ICB’s recommendations on
loss-absorbency and sees these non-structural reforms as an important
complement to ring-fencing in making banks better able to absorb
losses, easier to resolve if they do fail, and in curbing excessive
risk-taking. In particular:
* the Government intends to introduce higher equity
requirements for large ring-fenced banks, and will seek sufficient
flexibility in forthcoming European legislation to do so in the
interests of UK and European financial stability;
* the Government strongly supports a mandatory, minimum
leverage ratio for all banks, as recommended by the ICB, and believes
there may be a case for applying a higher minimum leverage ratio to
some larger banks;
* the Government agrees that the resolution authorities should
have a statutory bail-in power to assist in bank resolution. The
Government will seek to ensure agreement on including a robust bail-in
power in the European crisis management framework;
* the Government supports the principle that systemically
important banks hold a minimum amount of loss-absorbing capacity on a
group-wide basis. However, if a bank can show that its non-UK
operations do not pose a risk to UK financial stability and thus to the
UK taxpayer, this requirement should not apply to those operations;
* on balance, the Government supports depositor preference,
but believes that further analysis and consultation is needed on the
scope of its application; and
* the Government is of the view that supervisors should be
able to require firms that are difficult to resolve to have additional
loss-absorbing capacity.
More details on the ICB’s recommendations on loss-absorbency,
and the Government’s response, are set out in Chapter 3 below.
The ICB’s financial stability recommendations have a clear
focus on preserving the continuous provision of vital banking services
located in the ring-fenced banks. However, it is important to draw a
distinction between protecting the provision of critical services by
ring-fenced banks, and protecting investors. Requiring ring-fenced
banks to have more loss-absorbing capacity will ensure that the
continuous provision of banking activities can be maintained, if
necessary by imposing losses on investors – including creditors – not
by guaranteeing them. The Government’s view is that all banks should be
subject to normal competitive market forces, which means they must be
able to fail safely without relying on a government guarantee and
without putting the provision of critical services at risk.
The ICB’s proposals – by curbing incentives for excessive
risk-taking, reducing the exposure of ring-fenced banks to the
financial system and requiring non-ring-fenced banks to hold higher
levels of loss-absorbing capacity – will also increase the resilience,
and resolvability, of non-ringfenced banks. This is crucial. But in
order to be effective, this will require the introduction of a
resolution regime for all non-ring-fenced banks, including any that may
not be covered by the Special Resolution Regime. The Government
believes that all banks – including non-ring-fenced banks – need to be
resolvable without the use of state resources, and believes the ICB’s
proposals are an important step forward. But they should be
complemented by the introduction of a resolution regime that covers
investment firms and financial holding companies. This is discussed in
Box 1.A.
Competition
On competition, the ICB made recommendations:
* to improve prospects for a strong and effective challenger
to come out of the Lloyds p;
* to mitigate barriers to entry and anti-competitive
prudential requirements;
* to improve switching;
* to enhance transparency;
* to secure pro-competitive financial regulation; and
* on a possible future market investigation reference to the
competition authorities.
The Government strongly supports all these objectives. A
competitive banking sector is vital to ensure that the UK economy can
benefit from banking products and services at efficient prices.
Effective competition is also a spur to innovation and economic growth,
and can lead to better quality and service for consumers. The emergence
of a strong and effective challenger bank from the Lloyds p –
that would exert real, competitive pressure on the big banks – would be
good for competition. A regulatory focus on improving competition is
also consistent with strengthening the European single market – indeed
the European Banking Authority and other European supervisory
authorities are required to contribute to promoting “equal conditions
of competition”.3
The ICB’s recommendations on financial stability will also
help to address competition concerns in financial services, and
complement the competition recommendations. As the ICB noted in its
final report, financial stability recommendations that eliminate the
implicit government guarantee are themselves pro-competitive. Where
banks are regarded as ‘too big to fail’, market participants – in
particular debt investors – will contract with them on more favourable
terms than with smaller banks, distorting competition. Therefore
measures to tackle the implicit government guarantee will help to
remove distortions in the European single market.
Going beyond the ICB’s recommendations, the Treasury Select
Committee has called for the
Payments Council, a private sector body responsible for setting the
strategy for retail payment systems in the UK, to be brought within the
scope of regulation. The Government supports this, and will consult in
the New Year on options for enhancing the regulatory framework for
payment systems.
More details on the ICB’s recommendations on competition, and
the Government’s response, are set out in Chapter 4 below.
Economic impact and competitiveness
The ICB estimated that its package of recommendations would
cost the banks £4bn-£7bn a year. The ICB said this could have a
knock-on cost to GDP of around £1bn-£3bn a year, but this should be set
against the benefits of reducing the annualised cost of financial
crises of up to £40bn a year.
The ICB noted that the impact on the Government’s fiscal
position of the reform package would be complex but should be strongly
positive. However, the ICB did not attempt to quantify this. On
competitiveness, the ICB noted that its recommendations would only
affect around 15% of the banking institutions in the City and would not
affect insurance companies, fund management firms etc. By improving
financial stability the recommendations would in fact be likely to
increase the attractiveness of the UK as a place to do both financial
and non-financial business.
The Government has conducted its own economic impact analysis,
informed by modelling exercises carried out by the major UK banks. On
the basis of this work, the Government has concluded that while the
ICB’s estimates do not capture the full range of costs, the measures
that the ICB recommended will deliver net benefits to the UK economy
and the taxpayer.
The Government estimates the aggregate private costs to UK
banks at £3.5bn-£8bn. These additional bank costs are estimated to
produce a gross reduction in GDP of £0.8bn-£1.8bn, somewhat lower than
the ICB’s estimate. Against these costs should be set the potentially
much larger benefits to the economy from increased financial stability.
Based on the ICB’s estimate of the annual cost to the economy of
financial crises, even if other regulatory reforms reduced the
probability of a financial crisis by 30%, and the ICB’s recommendations
reduced the probability of a crisis by only a further 10%, and the
output loss caused by a crisis by 25%, the ICB’s recommendations would
yield an incremental economic benefit of £9.5bn per annum. The
Government therefore believes that the economic benefits of
implementing the ICB’s recommendations would significantly outweigh the
costs and will deliver significant net benefits to the economy and the
public finances.
On competitiveness, the Government is committed to ensuring
that the UK continues to be at the heart of the international banking
and finance sector. This is best achieved by establishing a stable
financial system in the UK, not by providing implicit taxpayer
subsidies to a small proportion of the financial institutions that
constitute the City.
More detail on these issues, including the Government’s own
preliminary analysis of the economic impact and competitive effects of
the ICB’s recommendations, is set out in Chapter 5.
Implementation
The ICB said that its recommendations should be fully in force
by no later than the start of 2019, consistent with the deadline for
implementation of the Basel III reforms agreed by G20 leaders. The
Government's intention is that implementation should proceed in stages
with the final, non structural, changes related to loss absorbency
fully completed by the beginning of 2019.
Primary and secondary legislation related to the ring fence will be
completed by the end of this Parliament in May 2015 and banks will be
expected to be compliant as soon as practically possible thereafter.
The Government will work with the banks to develop a reasonable
transition timetable.
This response sets out the Government’s initial views on the
ICB’s principal recommendations. The Government will bring forward a
White Paper in Spring 2012 which will set out detailed proposals on the
ICB’s recommendations, and launch a consultation.
Implementation of the recommendations will strengthen the
European single market, as one of the biggest distortions to this
market is the perceived implicit government guarantees. The ICB’s
recommendations represent the UK’s contribution to removing these
distortions. The
Government will work to ensure that current EU legislation does not
hinder the reforms necessary to ensure financial stability and a sound
financial system.
More detail on the proposed timeline and mechanics for
implementation – and their interaction with the development of relevant
European legislation – is set out in Chapter 6.
This response contains a number of outstanding policy
questions. The responses to these will be used to inform the detailed
proposals and further consultation that will be set out in the White
Paper. Details on how to respond to the policy questions are set out in
Chapter 6.
1 Effective
Resolution of Systemically Important Financial Institutions, Financial
Stability Board, July 2011. Available at:
http://www.financialstabilityboard.org/publications/r_110719.pdf.
2 Technical
Details of a Possible EU Framework for Bank Recovery and Resolution,
European Commission, January
2011. Available at:
http://ec.europa.eu/internal_market/consultations/docs/2011/crisis_management/consultation_paper_en.pdf.
3 Regulation (EU)
No. 1093/2010 of the European Parliament and of the Council of 24
November 2010.
Available at:
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2010:331:0012:0047:EN:PDF.
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Article Published/Sorted/Amended on Scopulus 2011-12-30 12:52:40 in Business Articles
