London: Financial services consultants and their UK banking clients face urgent strategic decisions following confirmation in the Queen's Speech yesterday that the government will legislate to "ring-fence" retail banking.
The controversial plans to split banks into their retail and investment banking functions as part of the Banking Reform Bill are the government's delayed response to recommendations by the Independent Commission on Banking (ICB) which reported last September. A white paper is now due in June.
Here practitioners from three elite financial services consulting practices consider the implications of this legislation for their clients.
James Curzon, Managing Principal, at dedicated financial services consultancy Capco.
In the recent Queen's Speech reference was made to the impending Banking Reform Bill which will implement the key recommendations of last year's Vickers Report. The Banking Reform Bill has a number of key aims, providing preventative banking operations to insulate customer and business services from Global Investment Banking meltdowns, separating retail and investment banking operations, including banks having to hold a higher proportion in capital as protection against future losses.
The impact of the Banking Reform Bill to the banks can be highlighted in four broad categories:
- Cost to implement: The high cost of implementation of the separation of retail and investment banking divisions for universal banks will be a significant cost over the coming four years, estimated to be between £3.5bn to £8bn. Operations, IT, Treasury, Compliance, Governance and customer segmentation will all lead to a financial burden for banking institutions, with likely costs to be transferred to the end customer/consumer.
- Capital adequacy: Having to hold a higher proportion of capital to protect against potential losses will create a burden of raising these funds on banking customers. This is likely to commence the end of free banking as the banks can no longer subsidise retail operations with profits from their investment businesses. If banks cannot use the revenue from investment divisions, the cost of borrowing is likely to be driven up.
- Customer leakage: Within the Banking Reform Bill are proposals to make it easier for customers to switch their account from one bank to another. This legislation is due to come into effect by September 2013, so banks will have to align both their customer retention strategy and product sets to allow the banks to retain customers.
- Globalisation: The Banking Reform Bill is heavy UK only legislation. The impact of the Bill on banking entities in the UK cannot be underestimated. Moving headquarters, offshoots and subsidiaries away from the UK could be a viable option to avoid both the Capital Adequacy requirements as well as the high implementation costs to meet the Banking Reform Bill requirements.
Kevin Burrowes and Steve Davies of PwC.
Kevin Burrowes, UK financial services leader at PwC, says, "Formally signalling intent to pursue ring-fencing helps eliminate uncertainty but, in reality, the banks are already well aware this would be pursued by the government. All banks are already undertaking enormous changes to their business models in light of trading outlook and pressure to generate acceptable returns for investors for the increasing capital that has to be invested.
"The emerging risk is that as the banks become regulated utilities, some banking activities may be pushed into the largely unregulated shadow banking sector. Fixing one problem while another begins to emerge must be avoided."
Steve Davies, UK retail banking leader, PwC, comments, "Banks will welcome further clarity on the proposals to ring-fence retail banking. The current proposals provide flexibility in how banks design their ring-fenced retail arms, meaning they will look different for different institutions, but should also minimise arbitrary winners and losers and help avoid unintended consequences.
"While the reform will not promote competition, and will require substantial costs to implement the changes, it should provide for greater transparency into the UK consumer banking aspects of these institutions. Several challenges remain, including the potential need to support the industry as it moves away from the free current account model which customers have become used to, but where there is an anomaly relative to most other developed countries."
David Parker, senior executive in Accenture's banking practice
The view at Accenture is that the ring-fence will be driven as much by existing internal business considerations — for example balance sheet structure and the funding mix — as by market-facing factors. Banks do however need to keep in mind the implications for their competitive positioning, culture and operations, it says. Optimal ring-fencing will be different for each bank as there will not be a 'one size fits all' solution.
Accenture believes there are four key factors that every bank should take into account when locating its ring-fence. They are:
- Capital constraints: The broader ICB recommendations will lead to generally higher capital buffer requirements in ring-fenced and non-ring-fenced banks.
- Funding: Some banks cross-subsidise their activities, such as using capital from corporate deposits to help fund retail lending or investment banking. While banks can still pass capital across the ring-fence, if they stay above minimum capital adequacy levels, it will be harder to do once a ring-fence is in place.
- Customer impact: Because many banks will implement similar service on different sides of the ring-fence, banks will need to keep a close eye on their positioning relative to their competitors and be alert to the risk of losing customers.
- Operational impact: Banks will need to show that, in the event of a failure, the ring-fenced bank will continue to be supported by key services for a period of time, enabling an orderly wind-down.