Retail ring-fencing of banks and its implications

Abstract

Abstract:Financial stability remains a key theme globally in view of the Eurozone debt crisis. The latest strategy by Germany and France is to ring-fence the crisis amongst the PIIGS countries: Portugal, Greece, Ireland, Italy and Spain. In the UK, the big four major banks have all responded to the Independent Commission of Banking's interim report key recommendation: ring-fencing retail operations into a separate subsidiary of any bank which wishes to operate in the UK. The report has clearly discussed the advantages and disadvantages of various types of subsidiarisation. Retail ringfencing is considered a compromise since full subsidiarisation is too costly and operational subsidiarisation is too minimal. The Independent Commission of Banking published its final report on 12th September 2011. They recommended ring-fencing retail banking and a 10% equity baseline. This paper focuses on structural reforms of UK banks. It aims to address the question of financial stability from a wider European perspective. The first question is whether cross-border retail banking in the EEA is best served by branches or subsidiaries? The second question concerns the legality of setting up subsidiaries in the European Union. Whilst there are no legal problems for UK based banks setting up subsidiaries for their retail activities, there might be a legal hurdle for requiring foreign banks setting up subsidiaries in the UK. The third question concerns EU crossborder banking regulation and supervision. Are the 'passporting system' and the home country supervisory approach still applicable in this post-financial crisis era?Many factors influence the choice of setting up branches or subsidiaries. However, the general position is that branches are more suited for wholesale/investment activities due to ease of funds transfer. Subsidiaries are more suitable for retail banking due to the limited liability principle and extensive local network. Effective cross-border banking must be accompanied by effective supervision and resolution regimes. The 'passporting' concept under EU law and home country dominance are somewhat dated post-financial crisis. Host country control should play a dominant part in financial regulation, especially in light of the importance of subsidiaries and the limited liability principle associated with them. The Icelandic bank crisis and collapse of Lehman Brothers International Europe illustrate the importance of host country control. Finally, the author argues that requiring banks to hold its retail activities in the form of subsidiaries in another European country is necessary to achieve financial stability.

Structural banking reforms and their implications for banks’ corporate governance

“…Therefore, the structural banking reforms following the financial crisis share the same regulatory objective, namely, financial stability. The reforms are intended to solve these problems summed up as “too systemically important to fail” by introducing a functional separation, which isolates certain risky investment banking activities from other banking businesses, particularly from those banking activities that are essential for the real economy (Armour et al , 2016; Binder, 2014; Carr, 2015; Kern, 2015; Lui, 2012; Proctor, 2015; Schwarcz, 2013). Structural banking reforms are supposed to reduce the likelihood of bank failures by reducing the channels of contagion between the two banking businesses and by reducing complexity they are expected to enhance banking supervision.…”

“…As mentioned before, the “intra-group structure” comes along with tensions. Whereas the existence of an independent governing body is one of the most essential parameters to ensure the isolation of certain banking activities within the separate entity, the tensions are even more perceptible for board members and management of the separate entity, as they are in charge to maintain the height of the ring fence (Lui, 2012). On the one hand, the board should follow the group-wide corporate governance standards and strategic objectives; on the other hand, its responsibility lies within the legality of the measures with regard to the structural obligations.…”

Macro and micro prudential regulatory failures between banks in the United Kingdom and Australia 2004‐2009

“…The author believes that this is positive news since depositors will receive more protection under the new recommendation. She has discussed the merits and shortcomings of retail ring-fencing in another paper (Lui, 2012). The author's descriptive data from Tables I and II shows that HBOS has an unusually high loan to deposit ratio.…”

Macro and Micro Prudential Regulatory Failures Amongst Financial Institutions in the United Kingdom: Lessons from Australia

“…She has discussed the merits and shortcomings of retail ring-fencing in another paper. (Lui, 2012) The author's descriptive data from table 1 shows that HBOS has an unusually high loan to deposit ratio. There is empirical evidence that there is a negative relationship between profitability and debt ratios (Kester (1986), Titman and Wessels (1988) and Rajan and Zingales (1995).…”