The UK’s Independent Commission on Banking has released its interim report proposing reforms of the banking sector to promote financial stability and competition. While the issues considered and the scope of the proposed reforms are significant, so too are the omissions. In particular, the link between financial stability and competition in the context of the reforms, is not fully explored.

The Independent Commission on Banking (ICB) was created by the UK Government in June 2010 in the wake of the financial crisis, and is led by the former head of the UK’s Office of Fair Trading (OFT), Sir John Vickers. The ICB’s mandate was to examine the structure of the UK banking sector and to recommend measures to promote financial stability and competition.

The ICB published an ‘Issues Paper’ in September 2010, opening a consultation that prompted over 150 separate submissions from a wide range of stake-holders. The highly-anticipated interim report attracted a vast amount of interest and publicity, such that the ICB’s website crashed within ten minutes of the report being released before the opening of the markets that morning.

The proposals for reform are aimed separately at improving the stability of the UK banking system on the one hand, and increasing competition in UK retail banking services, on the other.

Increasing financial stability

To improve stability, the ICB recommends increasing the loss-absorbing capacity of banks and implementing structural reform to create some degree of separation between retail banking, and wholesale and investment banking. The ICB proposes what it terms a “more moderate combination of these approaches”.

Specifically, the ICB has recommended that additional loss-absorbing capacity be introduced for ‘systemically important banks’, including wholesale and investment banks. This should comprise an equity surcharge of at least 3% above the Basel III requirements coupled with credible resolution plans, such as bail-in mechanisms, contingent capital and some form of depositor preference While the equity surcharge will be mandatory for large retail banking operations in the UK, given the international nature of wholesale and investment banking, the ICB considers that these operations of UK banks should not be required to have more equity than that ultimately agreed at international level, provided credible resolution plans exist.

In terms of structural separation, the ICB has recommended a UK retail ‘ring-fence’, in which UK retail banking activities can continue to be provided by universal banks which also engage in wholesale and investment banking, but must be contained within separately capitalised subsidiaries. The retail ring-fence would constrain a bank’s ability to move capital by insisting it maintains minimum safeguard levels in its retail operations.

Increasing competition

The ICB notes that the UK retail banking sector is highly-concentrated, with few ‘challenger’ banks to the established incumbents commonly referred to as the ‘Big Four’. The ICB considers that, in practice, banks in more concentrated markets tended to charge higher prices.

According to the ICB, the problem of market concentration has been exacerbated by the acquisition of HBOS by Lloyds TSB during the height of the financial crisis, which led to the Lloyds Banking Group holding a higher market share across all retail banking sectors than any other bank. While the OFT had objected to the merger on competition grounds, it was nonetheless pushed through by the then-Government which inserted the criterion of the maintenance of stability in the UK financial system as a new ‘public interest consideration’ on which the Government may intervene during the merger control procedure under the Enterprise Act 2002. The ICB is particularly critical of this decision, saying it bears “cause for regret”. While the merger gave temporary stability to HBOS, it jeopardised Lloyds TSB, and substantial government support was required for the merged entity, which was cleared under the European Union’s state-aid rules. The clearance was subject to the implementation of a restructuring plan which required a significant divestiture to limit the impact of the aid on competition.

While the ICB does not recommend reversing the merger, it suggests enhancing the divestiture of assets already required under the EU state-aid rules. According to the ICB, an enhanced divestiture is necessary to ensure a strong, effective challenger is created in the retail banking market. To the extent that an enhanced divestiture could not be agreed, the ICB recommends that the banking sector be referred to the UK competition authorities’ markets investigation regime, under which suitable structural remedies may be imposed. In contrast, the ICB does not recommend that the Royal Bank of Scotland divestiture, similarly required under the EU state-aid rules as a condition for the government support RBS received during the crisis, be enhanced.

The ICB also identifies switching difficulties by consumers as one of the most significant barriers to entry. To alleviate these difficulties, in the short-term, the ICB recommends a mandatory time period within which banks must guarantee that a switch be completed. In the longer-term, the ICB recommends the creation of a redirection system to transfer debits and credits between the two accounts.

Finally, the ICB recommends giving the future specialist agency which will be responsible for supervising the conduct of all systemic banking institutions, the Financial Conduct Authority, a clear primary duty to promote competition.

The ICB has opened a further consultation on these proposals and will release its final report in September 2011. While not binding, it is expected that the Government will have regard to the ICB’s conclusions on reform.


While the ICB’s recommendations propose a shakeup of the UK banking sector, many of the more radical measures that were foreshadowed in the Issues Paper, such as (i) full division between retail and wholesale and investment banking, (ii) imposing a cap on the size of a bank’s overall operations or (iii) the automatic blocking of a merger that breaches a certain market-share threshold, are considered and then rejected.

However the absence of certain aspects from the discussion is also significant. In particular, one of the much-mooted issues in the Issues Paper, the interaction between financial stability and competition, is not really elaborated upon at all. The ICB merely makes the cursory observation that the reform options aimed at promoting financial stability would improve conditions for competition by reducing the ‘too big to fail’ subsidy that gives ‘big banks’ an advantage over their smaller competitors. In addition, hidden away in an annex to the report is the fact that responses to the consultation affirmed that the link between financial stability and competition is “uncertain and empirical evidence inconclusive” and that “there was no reason why the two could not coexist, but that this relied on the presence of good regulation and transparency”. It would appear that the ICB has decided to defer this difficult question to the FCA, which, should it be given a primary duty to promote competition, may have to consider this matter on the systemic level.

The sectors which are not covered by the reform proposals are also notable. None of the reforms will be applicable to the so-called ‘shadow-banking’ sector, which the report defines as including, hedge funds, securities dealers, insurers and structured investment vehicles. Furthermore, the competition aspect of the ICB’s analysis was narrower still, only extending to the UK retail market and not incorporating wholesale and investment banking. The ICB notes the lack of response to the consultation in relation to this sector and comments that “the apparently sanguine view of many customers is at odds with what some of the wider evidence suggests … about how well competition is working in these markets”. However the ICB concludes that seeing these markets are international, “action at national level may have limited effect in this area,” and therefore it is not minded to explore competition in these markets further. Given this disparity between the coverage of the financial stability and competition aspects of the ICB’s report, perhaps it is not surprising that the report does not attempt to bridge the divide by exploring the link between the two.

The discussion on the conferral of competition competence to the FCA also impacts upon the ongoing consultation on the reform of the public enforcement system of UK competition law, launched by the UK’s Department for Business, Innovation & Skills in March. One of the matters being considered is whether the competition authorities should be obliged to keep ‘economically important markets or sectors’ under review: this aspect of the proposals is clearly aimed at the UK banking sector. Should the ICB’s recommendations on the FCA be followed and the FCA is given a primary duty to promote competition, this may pre-empt such moves.

Finally, the ICB mentions the issue of discriminatory pricing as one area of concern. This motivated the OFT’s unsuccessful attempt to challenge unauthorised overdraft fees on personal current accounts under consumer protection law in 2009. Given its resurfacing in the ICB’s report, it can be assumed that this will not be the last we hear on discriminatory pricing in the UK retail banking sector.