The Independent Commission on Banking (the “Commission”) has today released its final report on its consultation on reforms to the UK banking sector. The report contains recommendations to the government on structural reform and related non-structural reforms to the UK banking sector. The recommendations are designed to improve UK banking stability by promoting financial stability and improving prospects for competition in UK retail banking.

The full report is available here.

An analysis of the Commission’s Interim Report in April 2011, which discusses in detail many of the measures which went on to be final recommendations, is available on our Reg Zone - click here.

Instead of advocating an EU solution, the Commission has proposed a ring-fence which applies only to those banks unlucky enough to be incorporated in the UK. This reverse discrimination could penalise UK banks whilst leaving the UK market open to European banks which benefit from lighter regulation and freedom from the new rules under the EU single market system. 

The Commission estimates the cost impact of the changes will be £4bn-£7bn, mainly as a result of higher funding charges for banking operations outside the more highly capitalised ring-fenced entity. Commentators have highlighted the potential impact on lending activities and negative effect on short-term economic growth which could result from the large costs imposed on banks by the Commission’s recommendations.

The Chancellor, George Osborne, will review the ICB’s proposals later this year or next year. If the proposals are made law, banks may have until 2019 to implement them – the deadline for some elements of Basel III.  Critically, the length of time for implementation of the recommendations will allow the opportunity to negotiate in Europe for a more level playing field on resolvability. It will also mean that the final rules can reflect the lessons learnt from operating resolution plans under FSA’s new RRP (living wills) regime, which will come into force next year.

The key recommendations contained in the Commission’s final report are as follows.

Financial stability reforms

  1. Ring-fencing of UK retail banking activities

The UK retail banking activities of UK incorporated banks will have to be carried out in separate subsidiaries (i.e. “ring-fenced), which are subject to restrictions on their activities and group exposures. The UK retail banking subsidiaries will be legally and operationally separate from their groups, with separate capitalisation and distinct reporting responsibilities and governance arrangements. The Commission believes that ring-fencing will achieve the principal stability benefits of full separation from ‘riskier’ banking and investment activities, but at a lower cost to the economy than requiring this to be carried out in a separate group. 

While banking services such as taking deposits from customers other than individuals and SMEs and lending to large companies outside the financial sector will be permitted within the ring-fence, other activities will be prohibited, such as services (other than payments services) resulting in exposure to financial customers, services relating to secondary markets activity (including the purchases of loans or securities) and derivatives trading (except as necessary for the retail bank prudently to manage its own risk). Banks will be able to determine whether certain other activities are placed within the ring-fenced subsidiary or outside: for example, household mortgages and corporate loans. This creates a degree of flexibility within the ring-fencing recommendation. Building societies would also fall within the scope of the new rules.

  1. Capital Requirements

The Commission has recommended increased capital and loss-absorbing requirements for systemically important banks, specifically:

  • UK retail banking subsidiaries must hold equity capital of at least 10% of risk-weighted assets (an increase on the Basel III requirement for a 7% baseline ratio of equity to risk-weighted assets); and
  • Retail and other activities of large UK banking groups should both have primary loss-absorbing capacity of at least 17-20% of risk-weighted assets. There will be regulatory discretion about the exact amount and type of loss-absorbing capacity.