Banks face big decisions after UK reforms

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The Vickers commission paved the way for the biggest overhaul of British banking in decades as it unveiled a plan to force lenders to separate their core retail businesses from investment banking.

Broad parameters are set out in the reforms – retail and small businesses deposits and overdrafts must be included; pure investment banking and trading activities cannot be.

With the final bill to the industry estimated at as much as £7bn ($11bn), the banks face some big decisions. We analyse the potential impact on each of the big four institutions.

Barclays

As the UK bank with the greatest exposure to capital markets, Barclays is expected to be hit harder than rivals by the commission’s reforms.

Early estimates show that it could take the brunt of the cost increases – up to 40 per cent, according to one analyst.

This is because a higher proportion of its business would fall outside the ringfence, in the part of the bank considered most vulnerable to rising wholesale funding costs. Of Barclays’ total £1,500bn balance sheet, retail deposits account for only about £100bn.

The commission argues that both parts of the bank would lose their implicit government backing once its reforms were introduced – although some investors think this is only true of the businesses outside the ringfence.

Barclays has previously signalled that its preferred model would be a narrow ringfence that would include only the activities of retail customers and businesses with turnover of up to £5m.

Corporate deposits would continue to sit alongside Barclays Capital, its investment banking business.

This would help to diversify the non-ringfenced business, making it easier to fund and reducing the potential for cost increases.

Including corporate business would also mitigate the risks associated with having such a large standalone investment bank funded entirely through the wholesale markets.

RBS

Stephen Hester, chief executive of the part-nationalised bank, has been one of the most vocal critics of the ringfence idea, arguing that it would increase, rather than remove, risks in the system.

Also, the delayed implementation of the rules – while welcome from a practical point of view – is likely to mean that the government has to hold on to its 83 per cent stake for far longer than expected.

Like Barclays, RBS is expected to face significant cost increases – analysts estimate its bill could be about a third of the total £4bn to £7bn.

RBS also favours a narrow ringfence that would include only its core high street and small business operations.

Speaking at Barclays Capital’s global financial services conference on the day the Vickers report was released, Bruce Van Saun, RBS’s finance director, said this model would increase the diversity – and therefore funding – in the non-ringfenced business.

He was unconcerned about the tougher capital requirements in the commission’s report, which recommend banks hold a higher-than-expected 17-20 per cent of loss-absorbing debt.

Mr Van Saun said that assuming that there were effective measures in place to wind down banks in a crisis, he could see a “roadmap” to meeting the new rules. He also felt that at least some of the additional risk for bondholders had already been priced into debt costs.

Lloyds Banking

Lloyds would be the least affected of the British banks by the move to a ringfenced model, as a far smaller proportion of its business would sit outside.

Analysts have estimated that its costs would rise by a few hundred million pounds – a far lower amount than its more diversified rivals.

Generally, most of Lloyds’ wholesale activities are used to serve borrowers and are therefore considered more stable and potentially less prone to increases in funding than pure investment banking activities.

However, Lloyds also has to contend with specific recommendations on competition, the other focus of the Vickers report. The commission recommended that whoever buys the business Lloyds is selling to meet European state aid rules ends up with at least a 6 per cent share of UK current accounts – about a third more than was required under the initial terms.

Lloyds will therefore have to sell the business to an existing bank, hive off a bigger portion of its own customer base, or try to attract new customers who could be included in the sale.

These options are preferable to selling more branches – one of the options considered by the commission. Lloyds also dodged any direct attempt to shrink its dominant share of the current account market.

HSBC

As a bank with an unusually large retail deposit base, the concern for HSBC was that building a wall around its high street operations would in effect trap customer funds and make them less efficient.

The bank has a lower loan-to-deposit ratio than its rivals and so uses its surplus retail deposits to fund a wider range of lending and even some investment banking activities.

The flexible ringfence structure is therefore positive for HSBC, as it means it can include assets such as corporate loans in the ringfence and fund them from retail deposits.

The bank signalled that it supports the proposed additional loss-absorbing capital buffer and was already moving towards the 10 per cent capital requirement for the ringfenced business.

Analysts expect HSBC’s share of the cost burden to fall somewhere between that for Barclays and Lloyds. HSBC conducts the majority of its business outside the UK, which helps to water down the impact at a group-wide level.

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