No other month will offer as many possible alterations
to the UK banking sector as September, when the Independent
Commission on Banking proposes its final recommendations to reform
the market. Banks’ efforts to improve customer satisfaction are
clashing with the unavoidable new regulation, writes Duygu
Tavan.
Go deeper with GlobalData
The UK banking sector is set for a complete overhaul.
Banks’ desperate efforts to improve customer satisfaction are
clashing with the upcoming banking reform proposals by the
Independent Commission on Banking.
The Independent Commission on
Banking has had a year to review and compile reform guidelines to
stabile the UK’s banking sector. When he presents the Commission’s
final reform proposals on 12 September, chairman John Vickers will
not want to disappoint.
The interim report revealed the
Commission’s proposal to ringfence banks’ retail operations and
demand that banks hold 10% of their capital against assets. Now
there is speculation that the final proposals will be tougher than
initially expected.
When the Commission reveals its
final proposals, the UK government will decide whether to go
through with the proposals or adopt them in part. If the proposals
lead to legislation, banks’ investment businesses will be barred
from sourcing funding for their activities from retail
deposits.
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By GlobalData
The initial proposals have caused controversy and anger
within the banking industry – and there are mixed feelings. Some
argue that separating retail banking from wholesale banking would
also separate the business risks involved in both segments, thus
sheltering retail against the potential failings of investment
banking.
The opposing view is that such a
split will actually not spur financial stability, that it will have
a negative knock-on effect on the economy and that banks will
compensate higher costs with higher charges for customers. This is
the view within the UK banking industry.
The ICB’s argument is that, if at some stage the investment
banking division is on the brink of failing, it would be allowed to
do so without dragging the retail business down. The retail banking
business could continue to operate without being affected by the
financial failings of the investment banking unit.
In May, Lloyds Banking Group
criticised the ICB for allegedly failing to “fully analyse the way
competition in these markets actually takes place; it has also not
to date assessed the impact on that competitive process of the
switching and transparency measures we have proposed”.
However, the group toned down its
criticism in July before the final submission date: “Our view is
that full subsidiarisation provides a better cost-benefit trade-off
than either full separation or operational subsidiarisation.
“Anything short of full legal
subsidiarisation would be unlikely to achieve its three main goals
of protecting key functions, eliminating potential cross-subsidies
and enhancing the resolvability of universal banks. Full
subsidiarisation has the added advantage of being consistent with
existing insolvency legislation.(…) Putting the ringfence in the
wrong place could result in a severe funding shortage for, or
contraction in the supply of, some banking activities in an
economic downturn.”
For the likes of Barclays and Royal Bank of Scotland (RBS),
which heavily rely on internal funding for their investment banking
businesses from retail deposits (it is cheaper than external
funding), the ringfencing legislation would result in less
efficiency. That is not what these universal banks want after
disappointing interim results (see table, below
right).
The ICB came under fierce criticism
for these proposals by the Confederation of British Industry (CBI).
On the last day for responses to the commission’s policies, the
director-general of the lobby group for UK businesses, John
Cridland, voiced doubt over the commission’s
recommendations, arguing a lack of a “sufficiently strong case” for
the proposals.
“They [ICB] should not proceed with
the idea unless it stands up to a rigorous cost-benefit analysis,”
he said.
Cridland claimed it was “not clear”
that the current proposals would spur a financial recovery of the
banking system, warning the ringfencing proposals “could in fact
lead to greater instability”.
The CBI is demanding a more
flexible approach to ringfencing and Cridland warned the ICB’s
plans could result in riskier lending within the ringfence and
cause significant disruption to banks and businesses outside the
ringfence in the event of a crisis. “If the Commission does
progress with ringfencing, the scope must be sufficiently flexible
to recognise this,” he said.
“A one-size-fits-all solution would
force all banks to have the same business model, which would stifle
innovation, reduce competition, increase costs and hamper
growth.”
In its submission, the CBI demanded
that capital reforms should be agreed on an international basis to
cancel out a potential damage to UK banks’ level of
competitiveness.
If insider speculation is anything
to go by – no official comments were made to RBI at the
time of going to press – then the commission’s chairman, John
Vickers, is going to slap banks with tougher-than-expected
ringfencing rules. There is speculation among the sector that
Vickers will allow banks to implement these over the next eight
years. It is however regarded as unlikely that UK business
secretary Vince Cable would be happy about agreeing to such an
eight-year timetable.
The interim results of the UK’s
largest banks highlighted the difficult business environment for
the lenders. Four of the big five – Lloyds Banking Group, RBS,
Barclays and Santander – all reported a fall in net interest
income, proving Santander as the biggest loser among the four with
a 10% year-on-year slump to £1.85bn ($3.01bn).
However, unlike bigger rivals,
Santander posted a 7% increase in net fee and commission income on
the year ago period to £456m, although that sum is still less than
a third of the net fee and commission income of the other big
three.
The volatile banking and
macroeconomic environment continued to put pressure on banks’ net
interest margins, although only Barclays reported a rise from 1.39%
to 1.46% year-on-year in the first interim.
All bar Santander reported massive
slumps in half-year pre-tax profits – and in particular Barclays
and Lloyds whose profits were crushed by provisions for mis-sold
payments protection insurance.
This negative trend in banks’ balance sheets is unlikely to
change in the year ahead. Analysts predict that the ICB proposal
will push banks to fund higher operating costs by charging higher
fees on mortgages, credit cards and other consumer loans.
