Branches of U.K. high street banks, display their logos on signs, in Staines, Middlesex, U.K., on Feb. 1, 2008.  U.K. banks including Barclays Plc
© Bloomberg

British banks are learning to live with the ringfence. They still grumble about how much it will cost, but most top executives at the big five high street lenders believe they now have workable strategies for slicing up their businesses.

Under reforms first proposed by Sir John Vickers four years ago, which have become the UK’s main regulatory response to the financial crisis, banks with more than £25bn of deposits must hive off their consumer-facing business from riskier investment banking activities.

The rule — described by one senior executive as “seismic stuff” — is designed to protect taxpayers from ever having to bail out a bank again by ensuring that vital services, such as retail deposits or payment system operations, are kept separate from risks elsewhere in the financial sector.

It has produced a wide spectrum of responses, reflecting the sector’s various strategies. Some domestic-focused lenders, such as Lloyds Banking Group and Royal Bank of Scotland, plan to pack as much as possible inside the new ringfence they are building around their main consumer deposit-taking operations.

At the other extreme, Barclays plans to leave many businesses, including its Barclaycard credit card unit and international corporate loans, outside the ringfence so as to diversify the risk-profile of its large investment bank. Spain’s Santander also plans to have a “narrow ringfence”, with many UK corporate customers outside the perimeter.

Estimates of what it will cost range from £1.5bn at HSBC, one of the hardest hit because of its global and diversified business model, to “a few hundred million pounds” at Lloyds, which is widely reckoned to have the simplest task because 97 per cent of its assets will be inside the ringfence. Building societies are exempt.

Bruce Carnegie-Brown, lead independent director at Santander, says ringfencing “will require a lot of systems investment at a time when banks are investing in a lot of other systems improvements, including payment systems and mobile capabilities”.

The mood among top financiers has, however, shifted in recent months from widespread alarm about the reform to an air of quiet confidence that they can cope. Some are now growing impatient for the publication of the final rules.

HSBC was at one stage publicly threatening to spin off its UK retail operation because of fears it would struggle to control its independent board of directors. But it recently rebranded the unit as HSBC UK and dropped the idea of a spin-off.

charts: assets of Barclays, HSBC, and Santander

Next month, the Bank of England’s Prudential Regulation Authority plans to announce more details of how it will implement the ringfence.

Much is likely to be determined by how Andrew Bailey, head of the PRA, interprets the law. One bank chief says: “The watering down will be done by Bailey as he interprets the legislation.” The BoE declined to comment, but insiders privately dismiss the idea that Mr Bailey has vast room for manoeuvre.

There are three main areas where banks are pushing for more leeway. Firstly, many of them are appealing for more flexibility on governance.

In its consultation paper last year, the PRA proposed that at least half of a ringfenced bank’s board members should be independent, as should its chairman.

But Lloyds and RBS argue that because their ringfenced units will account for 97 and 80 per cent of their total assets respectively, they should be allowed to share a common board with the main holding company. Other banks also want flexibility to have a single finance director or head of risk overseeing both sides of the ringfence.

Some financiers argue they will struggle to find enough suitably qualified non-executive directors who meet regulatory approval. “There just aren’t enough people in the UK to populate all these new boards that they want us to create,” says one top executive. “Especially as a whole generation of bankers were wiped out by the crisis.”

Secondly, banks are anxiously awaiting PRA rules on capital requirements, both on a group level and for the ringfenced entity. The government has already said that ringfenced entities should hold extra capital buffers of as much as 3 per cent of a bank’s risk-weighted assets.

chart: Lloyds Banking and RBS assets

Some financiers say this could force a bank with a “narrow ringfence” — such as Barclays — to raise more equity because its large mortgage book will be penalised under the leverage ratio, which measures total assets against core equity capital.

However, a person familiar with Barclays’ plan, which will be put to its board this month, says the funding profile of its ringfenced unit can be balanced by including the UK corporate lending and wealth management activities alongside its mortgage book.

Other banks face a nervous wait to hear if the regulator believes both sides of their ringfence are financially viable. For instance, Santander’s activities outside the ringfence may initially lack sufficient scale and profitability.

Finally, some banks want more clarity on how to structure their vital back-office services — such as IT systems, accounting and human resources — to ensure they keep operating even if one side of the ringfence collapses.

Barclays and HSBC plan to carve these operations out into standalone units operating via an arm’s length service agreement with each side of the ringfence. Santander plans to run them from its UK holding company.

But Lloyds and RBS plan to include these operational activities inside their ringfenced units, arguing that their other operations lack the scale to be systemically important.

Lloyds is warning that it will simply offload its non-ringfenced arm — which will provide debt capital market services and complex derivatives — if the regulator forces it to spend hundreds of millions of pounds on building a separate servicing unit.

Amid all this structural re-engineering of Britain’s banking system, some bankers and experts worry about disruption to clients. “I genuinely think this puts UK banks at a disadvantage,” says Bill Michael, head of financial services in Europe at KPMG.

“The problem will be if you start telling customers that they can’t clear financial derivative transactions outside of Europe. What will they think? If you were a customer you would just go to a big foreign bank that is not affected by the ringfence.”

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