Independent Commission on Banking Recommends Banking Reforms

The Independent Commission on Banking was established in 2010 to review the structure of the UK banking industry. The commission was led by Sir John Vickers and included experts from various fields.

One of its key recommendations was to ring-fence retail banking from investment banking to reduce risk. This would involve creating a separate entity for retail banking to prevent the use of retail deposits for investment activities.

This separation would provide greater stability to the banking system by reducing the risk of bank failures. The commission also recommended that banks should hold more capital against their assets to increase their resilience.

The commission's report, published in 2012, proposed a number of other reforms, including stricter capital requirements and a new regulatory body to oversee the banking sector. These recommendations aimed to make the UK banking system safer and more stable.

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The UK banking regulation is a complex topic, but let's break it down. The UK government has been revisiting the ring-fencing of retail and investment banking activities of large UK-based banks, known as 'systemically important financial institutions (SIFIs)'.

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These banks are currently defined as those with more than £25bn of core retail deposits, but the threshold is set to rise to £35bn under the new regulations. Ring-fencing is the separation of one set of banking services from another, and the UK has adopted a functional approach, separating core retail banking services from investment banking and international operations.

The intention of ring-fencing is to protect essential retail banking services from the risks involved in investment banking activities and prevent contagion. This is a crucial step in maintaining financial stability and ensuring that retail banking services remain accessible to small and medium-sized enterprises (SMEs) and individuals.

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Borrowing cost will be a major concern for banks like Barclays, HSBC, and Royal Bank of Scotland, as their investment banking units will find it more expensive to borrow.

The government's priority will be to protect taxpayers' interests, not those of the banks. This means that the banks' financial obligations will take a backseat.

The banks' balance sheets are a staggering five times the size of the British economy, making it crucial for the government to act on this issue.

The UK's banking regulation has undergone significant changes in recent years. The Vickers Report, led by former Bank of England chief economist John Vickers, recommended a full-scale break-up of banks due to concerns over universal banks benefiting from an unfair government guarantee.

This guarantee allows universal banks to borrow more cheaply and fund their investment banking businesses, which can be highly profitable but also more risky. The report suggested separating investment banking operations into a subsidiary company to eliminate the risk of public losses.

The UK government has since implemented a ring-fencing arrangement to achieve this separation. Ring-fencing is the separation of core retail banking services from investment banking and international operations. This separation aims to protect essential retail banking services from the risks involved in investment banking activities.

The current threshold for ring-fencing is set at £25bn of core retail deposits. However, the government has announced plans to raise this threshold to £35bn, affecting systemically important financial institutions (SIFIs).

The intention of ring-fencing is to prevent contagion and protect retail banking services from the risks associated with investment banking.

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Ring-fencing was introduced by the Financial Services (Banking Reform) Act of 2013 to address issues that arose during the global financial crisis.

The Independent Commission on Banking recommended ring-fencing in 2011 to separate core retail banking services from investment banking.

The global financial crisis revealed that banks' investment operations had made significant investments in off-balance sheet securitised debt instruments, which led to substantial losses when the market crashed in 2007.

The UK government had to step in to save several UK-based banks from failing, which would have resulted in significant economic and social costs.

The Independent Commission proposed that the risks of banking should not be borne by taxpayers or ordinary depositors, and that structural separation of retail and investment banking could address this problem.

Ring-fencing aims to make it easier and less costly to resolve problems for banks that get into trouble, avoiding the need for taxpayer bailouts.

Structural separation should also help to insulate retail banking from external financial shocks, protecting customer deposits and essential banking services.

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The Independent Commission on Banking made some key recommendations that were accepted by the UK government. The commission's headline recommendation was that British banks should separate their retail banking divisions from their investment banking arms to reduce risk.

This separation, known as ring-fencing, would help to safeguard against riskier banking activities. The government announced plans to introduce legislation to implement this recommendation.

Raising the threshold for bank ownership in the UK could also promote competition. The commission argued that this could be a significant boost to investment and productivity.

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The Vickers Report made its recommendations to the UK government on 12 September 2011. The commission's headline recommendation was that British banks should 'ring-fence' their retail banking divisions from their investment banking arms to safeguard against riskier banking activities.

This recommendation aims to achieve the twin objectives of stability and safety, but the report concludes that it only goes halfway in achieving these goals. The ring-fencing may mean rating agencies give investment banks separate - and lower - credit ratings than their parent banks.

The commission also made recommendations on bank capital requirements and competition in retail banking. Some analysts believe Barclays has most to lose from any radical changes as its investment bank has earned more than £7bn in the last two years, or two-thirds of group profits.

The government announced the same day that it would introduce legislation into Parliament aimed at implementing the recommendations. Rating agencies will be looking carefully at the report to understand how it affects the chance of banks being rescued by the government in future financial crises.

Moody's, a rating agency, said on Thursday that it would review ratings for 19 UK banks this year in light of the tougher regulatory environment, with many likely to face large downgrades. One agency, Moody's, said on Thursday that it would review ratings for 19 UK banks this year in light of the tougher regulatory environment.

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The proposed threshold of £35bn may put UK institutions at a competitive disadvantage to outside entrants, as they can exploit scope economies and capital mobility within their international businesses to cross-subsidise their retail services in the UK.

Smaller entrants like Virgin Money, which was acquired by Nationwide, have a lower barrier to entry due to the significant barriers to entry in the UK market for retail banking.

Only six banking groups in the UK meet the current threshold, and raising it should not add significant compliance and efficiency costs for them.

Raising the threshold could lead to greater competition for depositors and SMEs, potentially boosting investment and productivity in the UK.

However, if new US entrants suffer problems, it won't be UK taxpayers who will be liable for the costs.

The commission's recommendations on 12 September 2011 included ring-fencing retail banking divisions from investment banking arms to safeguard against riskier activities.

The government announced the same day that it would introduce legislation to implement the recommendations.

Raising the limit is intended to facilitate greater competition in the retail banking sector, allowing US banks like JP Morgan and Goldman Sachs to expand their depositor base in the UK without bearing the regulatory burden associated with ring-fencing.

The proposals also include a new 'secondary' threshold, which will exempt banks providing primarily retail banking services from the rules governing investment banking accounts as long as their investment banking is less than 10% of their tier 1 capital.

Ring-fencing has been subject to criticism, which has led to calls for it to be scrapped. Banks themselves have been a major source of criticism, stating that the regulatory framework was complex and costly to implement.

The process of segregating activities can lead to inefficiencies, as banks may not be able to take full advantage of economies of scope between investment and retail banking. This can result in wasted resources and potential risks.

Banks also argue that ring-fencing can lead to a misallocation of capital, where resources are trapped in one part of the bank and cannot be used to invest in other areas. This can increase the risks of the specific areas.

The UK government's 2024 announcement to raise the threshold for ring-fencing from £25bn to £35bn has sparked a debate about the effectiveness of ring-fencing. Some commentators are calling for it to be removed altogether.

The Independent Commission on Banking proposed that the risks of investment banking should not be borne by taxpayers or ordinary depositors. Ring-fencing was introduced to address this problem, but its effectiveness has been questioned.