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Banks need 'regulatory consensus' across UK, EU and US, says expert

London's position as the leading centre for financial services in the world would be threatened if the Government bowed to growing pressure to establish an outright split between the retail and investment functions of banks, an expert has said.07 Jan 2013

In a new report, the Institute for Public Policy Research, a leading think-tank, has said that Government plans to 'ring-fence' banks' retail and investment activities are "too timid". It has instead called (72-page / 1.4MB PDF) for a complete separation of retail and investment banking into different organisations.

However, banking law specialist Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said that the IPPR's paper had failed to account for the global nature of banking and said implementation of its key recommendation would put the UK at odds with how financial institutions are regulated in the EU and US.

"There appears to be a gathering of support within the UK for a full separation of retail and investment banking as opposed to ring fencing," Anderson said. "This is not being proposed anywhere else. Rather than further divergence what we urgently need is regulatory consensus between the key jurisdictions affected by the financial crisis – the US, the Eurozone and the UK."

"The report doesn’t appear to address this need and focuses on the UK economy in isolation - there is little reference to the current EU banking reforms for example. Banking is a global business operating in a global economy, and according to the report, London is the leading global financial centre. This position needs to be preserved in a co-ordinated, regulatory risk framework," he added.

The author of the IPPR's report, the think-tank's senior economist and associate director for economic policy Tony Dolphin, said that whilst the ring-fencing of retail banking from investment banking would reduce the risk that taxpayers would have to bail-out failing banks, completely separating the two functions into separate organisations would "increase competition" and ensure no institutions grew to be 'too big to fail'. In addition, he said the move would reduce the cost of banking to consumers.

Dolphin said that the UK would benefit from greater competition in retail banking, and called on "barriers to entry" to the market to be reduced. He also said that senior directors and managers involved in investment banking should be made personally liable for financial losses when things go wrong. This would curb "excessive" risk-taking in the sector.

"In a situation where the government is forced to bail out the investment banking division of a bank, senior management (and the board) of the parent bank and the investment bank should suffer the internal equivalent of bankruptcy," Dolphin said in his report. "They would lose their jobs, together with any deferred bonuses and pension rights."

"In effect, this is an attempt to re-impose some of the constraints of the partnership model onto a sector that has largely abandoned it in favour of the relative security (for senior management) of the limited liability structure. This could operate in the context of a bank that has retail and investment banking operations, or for an institution involved only in investment banking," he added.

Last year the Government published a white paper on banking reform in which it detailed how "critical banking services" should be ring-fenced from riskier investment activities in order to protect them from wider economic shocks.

The ring-fencing of retail banking activities was first recommended by Sir John Vickers' Independent Commission on Banking (ICB) in its report on banking reform in 2011. By 2019 each major bank will have to ensure that separate subsidiaries within their wider group structures operate retail and investment banking activities.

Ring-fenced banks will need to be legally and operationally distinct entities from non ring-fenced banks, and will not be able to own or hold the capital of other non ring-fenced entities within the group. In addition, ring-fenced banks will not be able to carry out any activities through subsidiaries or branches based outside the European Economic Area (EEA).

Only ring-fenced banks will be able to accept deposits from and provide overdrafts to retail customers, according to the Government plans. Similarly, ring-fenced banks will not be able to carry out certain pre-defined activities including international and wholesale and investment banking services and dealing in investments as principal. However, ring-fenced banks may be permitted to provide "simple" derivative products to their customers provided that a number of conditions are met.

Last month the Parliamentary Commission on Banking Standards called on the Government to "electrify" the proposed 'ring-fencing' requirement after it warned that banks could 'game' the rules "unless incentivised not to". 

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