Of Special Interest

12th April 2011

UK Banking reform report significant

The Independent Banking Commission interim report is significant, and perhaps more radical than some give it credit for. The fact that it did not suggest the break up of any banks led to some media comments that it was weak or timid. The main recommendations involve:

- 1 Subsidiarisation. Where retail banking must be contained within a separate subsidiary with separate capital. It is similar to conditions laid down by many states insisting that any foreign bank incorporate locally with its own capital for similar reasons.

- 2 TBTF bank capital 3% above Basel III. The proposal is for the large UK banks to hold at least 3% higher capital than required under Basel III. This would suggest 10% core Tier 1 capital.

- 3 That Lloyds Banking group should make further divestments beyond those required by the European Commission as a remedy for state aid received.

- 4 Changes to make moving accounts easier including the possibility of transferring the bank account number with the customer.

Subsidiarisation was well trailed beforehand. It is also very difficult for banks to convincingly argue against. Some banks talked of inefficiencies in use of capital etc. The banks knew from the beginning that there were only two likely outcomes and this was the lesser of the two evils - the alternative being complete separation of investment and retail banking. Similarly, the news of a 10% core Tier 1 will not be welcomed but can be no surprise. Whether or not every state imposes this level on its TBTF banks, 10% CT1 has become the de-facto standard that large banks are judged by with a ratio above that 'strong' and below that 'average or weak' - including by the Credit Rating Agencies.

On account portability the banks will probably fight a rearguard action, delaying for as long as possible but will eventually comply as happened with faster payments. The concept that the same approach be taken as has been enforced with mobile phones and allow customers to take their bank account number with them is radical and would mean major re-engineering of the bank clearing system. Although involving investment to achieve it could save banks money in the longer term. Misdirected payments - the tracing of them and reapplying to the proper accounts is a major cost to the banks. Another proposal is that there should be a set time for account transfer to be completed within. The example used is seven days.

The biggest surprise contained within the proposals is the recommendation for 'substantial' further divestiture by Lloyds Banking Group. It is likely the bank will feel a certain amount of betrayal on promises made at the time they rescued the failed HBOS bank in 2008. This may prove one of the most controversial items.

The commission stated:

"5.13 The Commission therefore suggests that the Government seek agreement with LBG to enhance the divestiture substantially. An enhanced divestiture could give an improved outcome for competition, both by reducing market concentration and by strengthening the divestitures ability to act as a challenger. These competitive pressures should lead to improved prices, products and choice for customers, and to greater efficiency and innovation in the long run."

The IBC say it would be better to agree a compromise with Lloyds Banking but do not rule out using Competition Commission should this fail. The commission expresses regret on the decision to allow the Lloyds TSB acquisition of HBOS suggesting it was the wrong solution and wrong in general for the government to interfere with competition law. It does not believe that trying to unwind this acquisition would be practical. The commission expressed some concern over the RBS market share of SME banking but argued on balance against additional action. This was in part because it had already agreed the sale of branches to Santander and this deal could not be undone. If Santander was given more RBS branches then it could become too strong in this market and to sell an additional tranche to a new buyer was not viable.

The reasons for the commission concerns are demonstrated by the table at the bottom.

The British Bankers Association reflected the view that there was little value in a public fight over the principles. It warned over the possibility of possibly doubling up on other regulation and may be preparing for a battle over the detail - and the time-scales. Specifically the BBA commented:

"The UK's regulatory framework is also being dramatically changed with new and welcome focus on financial stability. Banks like any other company must be able to fail and not assume the tax-payer will step in.

"As such, due consideration must be given to where the the ICB's interim recommendations fit within this ongoing programme, some of which remains work in progress, with further changes due before the final report is due."

Estimated market shares after planned RBS and LBG divestitures

Personal Gross Unsecured Savings SME
Current Mortgage Personal Accounts Banking
Accounts Lending Lending Services

Lloyds 25% 19% 21% 18% 21%
RBS 15% 12% 8% 9% 24%
HSBC 14% 11% 7% 8% 15%
Barclays 13% 10% 13% 10% 18%
Santander 13% 19% 11% 13% 10%
Nationwide 7% 8% 4% 9% n/a

Source: Commission analysis of market shares for personal banking products taken
from OFT (2010) and market shares for SME banking services taken from Mintel(2008)

Executive summary: http://s3-eu-west-1.amazonaws.com/htcdn/ICB-Interim-Report-Executive-Summary.pdf

Interim report: http://s3-eu-west-1.amazonaws.com/htcdn/Interim-Report-110411.pdf