UK to ‘electrify' bank ring-fence in bid to end ‘too big to fail'

UK chancellor launches legislation to enforce ring-fencing – and separate banks that fail to comply
George Osborne is the UK Chancellor of the Exchequer

The UK's chancellor of the exchequer, George Osborne, today unveiled a new banking reform bill, which threatens the full separation of retail and investment banking activities in the event that banks are found to be flouting new ring-fencing rules.

The threat of separation, which has become known as ‘electrifying the ring-fence', was strongly supported by the Independent Commission on Banking set up by the government to reform the sector in an attempt to avoid a repeat of the taxpayer-funded bail-outs of the recent financial crisis.

In a speech this morning, George Osborne said that when Royal Bank of Scotland (RBS) required a bail-out in 2009, the UK had to rescue "not just the RBS on Britain's high streets, but the trading positions in Asia, the mortgage books in sub-prime America, the property punts in Dubai".

Osborne said the new legislation aimed to ensure that it is possible "to keep the bank branches going, the cash machines operating, while letting the investment arm fail".

Andrew Tyrie, the MP who chairs the Parliamentary Commission on Banking Standards, described the decision as "an important step in the right direction", adding that "electrification provides greater certainty for the banks: by making the ring-fence work they avoid the risks of full separation".

Fears over uncertainty for investors
The chief executive of the British Banking Association, Anthony Browne, disagreed, describing the government's move as "regrettable" and saying it will "create uncertainty for investors, making it more difficult for banks to raise capital, which will ultimately mean that banks will have less money to lend to businesses".

Browne said: "No other major economy is considering moving away from the universal model of banking because it undermines banks' ability to provide all the services businesses need."

A review undertaken by the governor of the Bank of Finland, Erkki Liikanen, on behalf of the eurozone, has recommended "legal separation of certain particularly risky financial activities" within banking groups, with banks exceeding an ECB-mandated threshold having to transfer all investment activities to a separate legal entity. European commissioner Michel Barnier is expected to bring his proposals, based on the Liikanen review, to the European Parliament in September.

In the US, the proposed ‘Volcker rule' would require complete separation of speculative trading activities from market making activities at banks.

Tony Anderson, a partner in the banking team at law firm Pinsent Masons, said: "The UK is currently the only jurisdiction in the world that is specifically ring-fencing retail banking activity from other banking operations. Other jurisdictions are focusing on separating only certain parts of investment banking activity, such as the trading of the bank's own assets.

"These measures will only reinforce this differentiation, making it harder for universal banks with global operations to continue to maintain the same operations in the UK in an already difficult trading environment."

Anderson added that the new approach may make it harder for the government "to decide the optimum time to reduce their current holdings in UK banks". "There could be significant political fallout for the government from any proximity between a sell down of shares in a state-owned bank and a full separation of banking operations following a breach of the ring fencing measures," he said.

Ring-fence could undermine stability
Charles Goodhart, a former member of the Bank of England's Monetary Policy Committee, said on a panel discussion this morning that he thought ring-fencing has the potential "to make both parts of the banking system less stable than they were before".

However, he conceded the liquidation of a retail bank is "not too problematic" compared with that of an investment bank, which is "far more interconnected through all the financial and capital markets".

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