UK Banks Brace for Radical Overhaul

The United Kingdom proposes to overhaul the country’s banking system to diminish risks to taxpayers and public finances in future financial turmoil, by acting upon recommendations of the Independent Commission on Banking (ICB)[i], which presented its report onSeptember 12, 2011.

Chancellor of the Exchequer (Finance Minister) George Osborne praised the report as an “impressive piece of work”, and said the Government would look to implement all of the Commission’s recommendations by 2019 – the date suggested by the ICB.

The ICB was created by the British Government in June 2010 with the task of considering possible structural and non-structural reforms of the country’s banking sector to promote stability and competition, to reduce risks to taxpayers and public finances, and to make recommendations to the UK Government by the end of September 2011.

The Commission is headed by Sir John Vickers; the 363-page report is therefore also known as the Vickers Report.

According to the ICB report, the uncertainty about the banking system requires the adoption of swift reform measures. Nonetheless, given the scale of the reforms it proposes and the sums needed to implement them, it expects the deadline for their full application to be extended into 2019. At the same time, the Commission pleads for immediate introduction of operative changes.

A number ofUKbanks combine domestic retail services with global wholesale and investment banking operations. “Both sets of activities are economically valuable while both also entail risks – for example, relating to residential property values in the case of retail banking. Their unstructured combination does, however, give rise to public policy concerns, which structural reform proposals – notably forms of separation between retail banking and wholesale/investment banking – seek to address,” explains the Commission.

The ICB recommends retail banks to hold in reserve at least 10 per cent of their high quality domestic retail assets as stocks or retained profits, in order to absorb the impact of potential losses or face future financial crises. Large banks, it says, should maintain safety buffers between 17 per cent and 20 per cent of their highest quality assets, which can be easily turned into capital.

Also, the Commission advises on establishing a ring-fence[ii] for retail banks on British land, on the following terms:

The Commission’s view, in sum, is that domestic retail banking services should be inside the ring-fence, global wholesale/investment banking should be outside, and the provision of straightforward banking services to large domestic non-financial companies can be in or out.

Nowadays many banks, especially large banks, supply services in retail banking as well as wholesale/investment banking. 

‘Separate Retail Banking Businesses’

Retail banking services mainly comprise deposit-taking, payment and lending services to households and small/medium businesses. Investment banks; on the other hand, they deal among others with high risk operations, with complex derivatives (mortgage-backed or asset-backed securities), investment and hedge funds, short selling and naked short selling.

When these banks face problems, as they did during the 2008 crisis and the ongoing one, all of their services become affected and support the bank losses, and in case of a public bailout, the country’s taxpayers bear the costs of maintaining a complex and risky banking system.

British banks and Europeans in general face serious risks today, including huge liabilities and large jeopardized sovereign bond holdings. United States recently manifested its concern about the solvency of European banks located on the American territory, though as a matter of fact those banks do not get funding in the US.

With the proposed separation, retail banking businesses, of much lesser risk and with deposit protection systems, would become isolated from the consequences of the high risk operations of investment banks.

In order to do that, banks must separate into two different entities: one for retail services and the other for the investment bank. Retail banks would then operate as independent legal entities and under a different system of regulations. 

Global Centre for Banking and Finance

Chancellor Osborne said the report would meanUKbanks could remain competitive.

“The government wantsBritainand the City ofLondonto be the pre-eminent global centre for banking and finance. We want universal banks headquartered here with all the advantages that brings,” he told the Parliament.

“The global investment banking operations ofUKbanks can continue to be as competitive as any in the world,” he added.

The banking sector has opposed these reforms in particular since the ICB began its working, although it is more appropriate to say that the bank opposes any reform which limits its operations or its profits.

The Commission recommends many other changes, even if it is difficult to predict if any or all will come into effect. As the European crisis persists, no one can ensure whether immediate or very short-term measures will not have to be applied to the financial sector. In any case, 2019 is rather far away and many things along the way may be modified by the bank lobbying.

Notwithstanding such a possibility, we are once again confronted with unilateral regulation measures, which protect or regulate certain internal jurisdictions, but promote financial centers which export high risk operations to other more open or unregulated markets. 

Protection or Protectionist

In this case, while the proposed reform protects Britain’s taxpayers – in fact it is by itself a protectionist measure inside the borders of the United Kingdom, it does not modify British banks’ global operation practices, among which are those that provoked the implosion of toxic activities in 2008, or the recent speculation against sovereign Greek, Spanish or Italian bonds, to mention a few.

Whether the proposed reform is implemented or not, the very fact that the United Kingdom, which harbours the world’s oldest and one of the most powerful financial centres, begins to consider an overhaul of the banking system, indicates that the crisis has profoundly shaken the very foundation of the banking and financial sector – and this to an extent that cannot be gauged from available information; in particular the figures on liabilities and activities exposed to risks.

Until now, even after a reiterated call in the G-20 summits which took place during the toxic assets crisis, no initiatives for an arranged financial regulation on a global scale have been undertaken. And it is doubtful that they will come up in the midst of the crisis of the developed world. In fact the scale of this crisis is the main reason for the long eight-year term proposed by the ICB.

However, the British initiative, in spite of the 2019 deadline, speaks volumes and should serve as an early warning, so that the authorities of other countries – especially emergent and developing – adopt national and/or regional measures to safeguard their taxpayers and their economies on time.

By Raúl de Sagastizabal


[ii] Retail ring-fence/ring-fence: The isolation of certain retail banking services in an independently capitalized entity.

Ring-fenced bank: ‘Ring-fenced banks’ are independently capitalized banks that are exclusively permitted to provide certain services. Safeguards limit their exposure to other activities.


Translated by Daniel Cisneros