It seems there is no regulatory change too small or questionable not to be dressed up in the rhetoric of Big Bang 2.0 and Brexit dividends.
The latest is ringfencing, the UK rules introduced after the banking crisis that require lenders with more than £25bn in deposits to separate their consumer operations from riskier investment banking activities. Andrew Griffith, the new City minister, said this week that reforms could “release some of that trapped capital over time around the ringfence.” The suggestion is that UK lenders with limited or no trading activities, like Santander UK, TSB or Virgin Money, could become exempt from the regime.
For a start, any change has precisely nothing to do with post-Brexit regulatory freedoms. Ringfencing was a regime unique to the UK, designed in the words of its architects to “isolate those banking activities where continuous provision of service is vital to the economy.” The UK created it. The UK could always change it. Indeed, the fact that ringfencing is UK-specific is often used to argue against the regime by banks.
The mooted changes are also in line with a review by Keith Skeoch, published in March, which was supportive of ringfencing. The regime still had merit, it said: the focus could be narrowed to the largest most complex banks and it could be made more flexible, especially as other measures make bank failures easier to handle without taxpayer support. But it largely dismissed complaints that the ringfence had damped competition or fuelled an overheated mortgage market. The broad principle of insulating UK domestic deposits from other activities remained still sound.
There is a danger here that initial tweaks are simply the thin end of the wedge, emblematic of a regulatory pendulum that has swung back in the global banks’ favour as memories of the 2008 carnage have faded. After all, a review originally intended as a chance to strengthen ringfencing, or consider full separation, looks likely to result in changes in the other direction.
But the Bank of England this week proposed strict implementation of the latest global rules on bank capital, rightly reinforcing the idea that high standards and robust institutions are a competitive advantage for a jurisdiction. Frankly, lenders who come out of the ringfencing regime could be trading one type of enhanced regulatory scrutiny for another, if there is a risk of regulatory arbitrage or business drift in institutions where UK retail and small business deposits aren’t cocooned in their own entity.
One irony is that this push for reform comes just as there is evidence that ringfencing has worked as intended. Research done by Warwick Business School with the Bank of England, published in October after the Skeoch review, looked at repo market data and found that ringfenced institutions enjoyed a lower cost of funding justified by reduced risk-taking, a “bonus” that proved enduring in times of market stress like the pandemic. The results suggest that “the entities that hold domestic savings have been made less risky, without damaging other institutions,” said John Thanassoulis, professor of financial economics at Warwick.
The benefits on offer here by exempting smaller institutions are also debatable. “I don’t think trapped capital is the issue,” said one senior banker. “It’s more trapped ML funding,” referring to the restrictions on the use of UK deposits. The systemic capital buffer imposed on larger ringfenced banks wouldn’t impact the likes of TSB and Virgin Money anyway. And limiting the use of UK deposits to fund investment banking or overseas activities was rather the point of the ringfencing regime.
Banks already have some flexibility on UK activities permitted within the ringfence, including some hedging and lending for big companies: the focus on mortgages has been as much a function of strategy and risk appetite as anything else. “I don’t see the obstacle to [UK] infrastructure investment,” said one expert, referring to the government’s goal to encourage more money into UK projects.
Another suggested an exemption could free up management time spent on compliance but not much more.
Unless this is the start of a broader move to unravel the ringfence, this reform looks more whimper than bang.