The Independent Commission on Banking (ICB) released its final report on reforms to the UK banking sector on 12 September.  Just a few days later, speaking at a conference of bankers in London, the veteran venture capitalist Jon Moulton summed up the report using the famously ambivalent prayer of Saint Augustine, “Lord, give me chastity and continence, but not yet”.  Meanwhile, the revelation that a rogue trader at UBS had lost over £1 billion led others to argue that the reforms should be implemented as soon as possible.

The argument for banking reform is hard to avoid.  The UK has a strong financial services sector whose assets dwarf GDP by a factor of 4.5.  The ICB was asked by the government to make recommendations to maintain the financial services industry while reducing the risk that the UK taxpayer be required to fund another bail-out of ‘too big to fail’ banks. 


The key recommendations which are intended to improve the financial stability of UK banks are summarised in the box below, but principally comprise:-

  • structural reform of banks: the retail operations of UK banks are to be ‘ring-fenced’ from the riskier investment banking operations;
  • increased capital and loss-absorbing capacity for the largest banks;
  • measures to increase competition, one of which will impact the sale of Lloyds Bank branches.

The recommendations of the final report closely follow the form of the interim report which was issued in June and attracted the support of UK Chancellor George Osborne.  In the past few months the banks have lobbied hard, both against the proposals and, more realistically given the Chancellor’s support, for more time to implement the changes. 


There are indications that the banks were partly successful in that the changes may not be implemented until 2019.  It was also notable that although bank share prices fell on the news, Barclays’ head Bob Diamond was reported to be “pleased” with the report.  However there may be further relief for banks in due course which, for political reasons, must remain opaque at present.  In responding to the final report, George Osborne said that he aims to introduce legislation to implement the proposals within this Parliament (before 2015), but that there will be further consultation in relation to the legislation.  No doubt there will be further lobbying at that stage, hoping to water down the proposals. 

The report suggests that once the ring-fencing reforms are in place, between a sixth and a third of aggregate UK bank balance sheets (currently over £6 trillion) would be within the ring-fence.  The banks most affected will be Barclays and RBS, followed to a lesser extent by HSBC. 

One of the most striking aspects of the proposals is that they will affect only UK banks and that no other international  financial regulator has chosen this path.  UK banks will be doubly penalised in being subject to more complex and costly regulation as well as an enhanced capital adequacy regime.  The ICB estimates the cost of the changes will be £4 billion to £7 billion, and believes that these costs will largely fall on the investment banking operations in the form of higher funding charges.  But there is a risk that increased costs may have a wider adverse impact on lending and consequently on economic growth.  Another likely impact will be the end of ‘free’ current account banking for individuals.  It has also been suggested that both the retail and investment arms of post-reform banks will find it harder to attract equity investment, the former because its business will not generate adequate returns, the latter because it will be seen as too risky. 

There is some debate risk that European Economic Area (EEA) banks subject to looser regulation than the UK ring-fenced banks may try to capture some of the UK market for retail banking.  The ICB also notes that a possible outcome of its recommendations is that UK banks might relocate overseas, although that has not been suggested publicly by any of the banks so far.

Capital requirements

The ICB proposal recommends increased capital and loss-absorbing requirements for systemically important banks.  These requirements are considerably in excess of the Basel III requirements - if the proposals had been in place during the banking crisis all UK banks would have survived without needing any of the eventual £850 billion government assistance.

It is largely because of the scale of these requirements that the ICB recognises that implementation cannot be speedy; the backstop date of 2019 is to co-ordinate with the implementation date for Basel III.  It is interesting that the EU is implementing the majority of Basel III measures (including those for capital requirements) in the form of a regulation, which will be directly applicable in EU member states, rather than a locally implemented directive.  This form of implementation has been planned specifically to avoid the possibility of individual state regulators ‘goldplating’ or making additional requirements.  Thus, the ICB’s proposals conflict with the EU plans and the banking lobby will no doubt now raise these issues with the EU bodies as well as attempting to water down the proposals as they are introduced as legislation.  That said, Michel Barnier the EU Commissioner responsible for Basel III implementation has previously stated that he believes that there should be sufficient flexibility to allow the UK to implement the ICB’s proposals.

A further recommendation is that those deposits which are guaranteed by the Financial Services Compensation Scheme (principally individuals’ deposits up to £85,000), should be preferred over unsecured debt in a bank insolvency.  This measure complements the requirements for loss-absorbing capital which would thus be subordinated to depositors (and their guarantor, and in the last resort the UK Treasury).  Adopting a depositor preference measure would bring the UK into line with a number of jurisdictions including Australia, Hong Kong, Switzerland and the US.


The ICB believes that if there are more UK retail banks, then the risk of any individual bank being ‘too big to fail’ will reduce.  Additionally, if the UK banking market is divided between a larger number of banks, the consequences of any failure will be smaller.  The ICB is therefore proposing a package of measures to improve the likelihood of customers switching banks and to make the process easier. 

In relation to the EU-mandated sale of part of the Lloyds Bank Group branch network, the ICB recommends that Lloyds reach agreement with the government that the purchaser should have at least 6% of the personal current account market.  This is a partial reprieve for Lloyds, which might have faced calls for a larger divestment programme.  The much discussed potential bid by National Australia Bank now seems to be unlikely, but the investment vehicle NBNK (likely to bid for the branches and assets of Northern Rock) has confirmed a bid for the divested Lloyds branches.


The ICB’s recommendations intend to “reconcile the UK’s position as an international financial centre with stable banking in the UK”.  By proposing measures not suggested by any other regulator, and imposing capital requirements in excess of Basel III, it can be argued that the ICB puts more emphasis on stability than the UK’s international financial status.  Clearly this plan may substitute the economic risk of bank failure with the economic risk of a shrunken market and loss of business to overseas rivals not subject to the same rules.  However the current economic and political climate requires action against the banks and the broad terms of the recommendations have been welcomed by many commentators.  Whether the government introduces the proposals in their full form, or whether some of the more difficult measures will be diplomatically ‘kicked into the long grass’ by the extended consultation and implementation process remains to be seen.  

Structural reform

  • The retail and investment banking operations of domestic banks will be ‘ring-fenced’ within each organisation - this is not quite a re-run of the US Glass-Steagall Act of 1933 (which  prohibited commercial banks and securities-issuing investment banks from being part of the same banking organisation), but is a stricter separation than many bankers had hoped for.
  • Certain retail operations can only be carried on within the ring-fence including deposit-taking and overdraft lending to individuals - these ‘Mandated Activities’ are seen as services where even a brief interruption of service will have a significant economic impact.
  • Other banking operations which would make it harder or more costly to achieve an orderly resolution of a failing bank or which increase its exposure to global markets must not be carried on within the ring-fence; these prohibited activities will include derivatives, provision of services to non-EEA customers, secondary market activities and trading.
  • Lending to domestic corporates can be conducted from either side of the ring-fence.
  • The ring-fencing rules will apply to any business carrying on Mandated Activities in the UK with permission from UK regulators - this will apply to all UK banks and UK subsidiaries of overseas banks, but not to EEA banks, which act under a ‘passport’ from their home regulator.
  • If what is described as a 'significant' non-EEA bank wishes to carry out Mandated Activities in the UK, it should form a UK subsidiary which will then be subject to the rules.
  • Each ring-fenced retail bank must have an independent board of directors and chairman.
  • The ring-fenced bank should be a separate legal entity and meet regulatory requirements on a standalone basis and deal with its associated investment bank on an arm's length basis.  Ring-fencing would not prevent the investment arm from subsidising the retail arm.  

Capital requirements

  • UK retail banking subsidiaries should have equity capital of 10% of risk-weighted assets (this is 'goldplating' of the Basel III proposal of 7% of RWA).  Investment banks are not subject to this extra requirement.
  • Large UK banking groups must have bail-inable capital of at least 17% of risk-weighted assets, made up of equity, bonds and contingent capital. Supervisors should be able to raise this to 20% in the case of complex bank groups.
  • UK depositors will have preferred priority over creditors in any insolvency (up to the £85,000 individual guaranteed deposit level).

Competition measures

  • In relation to the EU required sale of part of the Lloyds Banking Group branch network, the ICB recommends that the sale should result in a strong challenger to the existing retail banks, having at least 6% of the UK market for personal current accounts.
  • Proposals will be developed to make it easier for customers to transfer their personal and business accounts by 2013.
  • The ICB supports measures designed to increase price transparency to encourage consumers to shop around for the best package.