With less than a year to go before UK banks need to separate retail and commercial operations, we take a look at what ringfencing is and who will be affected
Monday 15 September 2008 – a bleak, autumnal morning in the City of London. Rain is in the air. Dead leaves lay trodden on the dirty ground. The rush of commuters flocking into the City after the weekend begins earlier than normal. Coffee shops are bristling with people loading up on caffeine before heading into the office. There’s tension in the air.
TV screens on the trading floors are tuned in to the news channels – news channels are broadcasting from the trading floors. Spreadsheets are hastily prepared for impromptu, hurried early morning meetings, with people from across the business in nervous attendance. There aren’t enough seats for everyone. Stunned people look at each other, before one individual eventually summons up the bravery to ask…
“So, how much exposure do we have to Lehmans and Merrill Lynch?”
The financial crisis of 2008 rocked markets around the world. Companies that were ‘too big to fail’ failed. In London, both RBS and Lloyds Bank had to be given government bailouts. Northern Rock would be less fortunate.
Politicians ordered investigations. In the US, the Dodd-Frank Wall Street Reform Act would bring greater transparency to financial transactions. In Europe, Basel III would order companies to hold higher levels of capital in reserve.
In the UK, the Vickers Commission called for the introduction of ringfencing in the hope of preventing another banking crisis in the future.
So, what exactly is ringfencing?
Ringfencing is the structural separation of retail and commercial operations in UK banks. Legislation comes in next year – on 1 January 2019 – although banks have been preparing for this change for several years.
UK banks will have to physically split their global, commercial and investment divisions from their UK retail banks. For some, this could mean opening new offices and moving staff. HSBC, for example, is building an office in the Midlands to house its ringfenced business from 2019 onwards. The iconic tower at Canary Wharf, meanwhile, will become the HQ for its global, non-ringfenced, operations.
Firms may need to change legal entities as a result of this corporate restructuring, while IT systems will need to be split in two.
That sounds a bit technical – what’s the simple version?
Ringfencing isn’t a simple affair – but, in a nutshell, the services that customers would get in a branch or online, or which small businesses would use, will be separated from the investment banking and global operations of the giant banks. However, this does depend on what services each of the affected banks already offers.
The idea is that the essential parts of the business will become safer, making it less likely that everyday people will be affected by a failure in the riskier parts, such as investment banking.
So, even if the bank does crash, the new rules should make it easier for the Bank of England to keep the retail bank running.
Which banks are affected?
Banks and building societies with average deposits of £25bn over a three-year period will need to comply with ringfencing. At the moment, there are six UK banks affected – HSBC, Barclays, Lloyds Banking Group, RBS, Santander UK and the Co-operative Bank.
And what about the Channel Islands?
Tracy Garrad, Chief Executive at HSBC Channel Islands and Isle of Man, explains: “For many of the Channel Islands banks, their operations here will historically have been part of a UK set of operations and legal entities. These need to be separated – and that’s why ringfencing does have a direct impact on us in the islands.”
Why has ringfencing come about?
The 2008 financial crisis led to the freezing up of the financial system. “It actually affected communities,” explains Graham Marsh, Head of Banking Relationships at Equiom in Jersey.
“People couldn’t access their money, get a loan or a mortgage, because institutions were no longer accepting them for finance. At the same time, lending rates became quite severe, and that had another knock-on effect on communities. in that the cost of debt became significantly higher.”
A financial crisis like that couldn’t be allowed to happen again. So, the UK government assembled the Vickers Commission, made up of several high-profile names, including Oxford academic Sir John Vickers, banker Bill Winters and Financial Times columnist Martin Wolf.
It was the Vickers Commission that came up with the idea of ringfencing, which both the Financial Conduct Authority and the Prudential Regulation Authority subsequently backed.
What does it mean for customers?
Although many of the changes brought about by ringfencing will not be visible outside of the banks, some of them will have an impact on customers. The banks have already been proactive in explaining these changes to their customers and, where possible, changes to things such as sort codes and international banking account numbers (IBANs) will be automated.
Activities such as the issuance of new bank cards, however, will require customers to take action.
Will the cost of banking go up?
Banks have been working for several years to prepare for ringfencing – work that’s required a large amount of resource. Is there a risk, therefore, that customers will have to foot the bill?
“We won’t be increasing our charges directly as a result of ringfencing, and I can’t imagine other banks will either,” says Tracy Garrad. “In fact, in our case it’s going to give us more autonomy to really specify both our proposition and our pricing structures with much more relevance to our local market.”
But not everyone believes pricing will stay the same. Whether it’s as a direct result of ringfencing or not, some say free banking may not be sustainable in the long term.
“We’ve been through a phase over the past 20 years where we’ve gone from being charged for the account to having free banking,” says Graham Marsh. “I do suspect charges will go up for holding bank accounts.”
What are the implementation challenges?
One of the biggest challenges that’s facing banks is unweaving the financial records of retail and commercial customers on ageing IT systems. Data for ringfenced and non-ringfenced customers will need to be migrated to separate infrastructure, a painstaking and delicate piece of work where 100 per cent accuracy is essential.
The timing of the legislation is also significant, coming as it does just weeks before the scheduled conclusion of Brexit. “It could be challenging,” says John Stubbs, Senior Partner at Bank Brokers UK. “Brexit is a big concern for the banks, and ringfencing lands at virtually the same time.”
Then there’s additional legislation coming in alongside ringfencing, such as the systemic risk buffer (SRB). SRBs are calculated as a percentage of a bank’s assets under management – the higher the AUM, the larger the buffer they’re required to hold.
It’s designed to ensure firms have enough capital in reserve to deal with any distress or failure they may experience.
“Having the bigger buffer of equity is a big demand,” Stubbs continues. “It could present companies with accounting challenges when it comes to showing their profitability and performance.”
So, will ringfencing prevent another banking crisis?
Ringfencing and the capital reserve provisions are two pieces of legislation designed to prevent a similar financial crisis to the one experienced in 2008. But that’s not to say that a different type of financial crisis couldn’t happen at some point in the future.
“It’s far more than just a network of banks,” Stubbs adds. “The next crisis could be a major cyber attack, or the payments network could collapse, as opposed to the banks themselves failing.”
But overall, ringfencing’s a good thing, yes?
The financial crisis was a bleak time for the markets, and for companies, investors and customers alike. No one wants a return to those dark days, and if ringfencing helps prevent that, it has to be a good thing.
“My general philosophy to new regulation is that it always comes from a place of good intent,” Garrad concludes. “For consumers, and for their trust, faith and belief in banks, and the protection of consumers in the future, it’s definitely a positive thing, however complex and difficult it has been to do. I think the future of banking, in Europe and globally, is definitely on a more solid footing.”