The Government is
today publishing its response to the report by the Independent
Commission on Banking (ICB), which sets out plans to fundamentally
reform the structure of banking in the UK. This response agrees
with the ICB’s recommendations and outlines how the Government
will legislate to create a stable banking sector that supports
lending to businesses and families, and removes the implicit
taxpayer guarantee in the event of a bank failure.
The Government will implement the ICB’s advice in stages with the
full package of reforms completed by 2019. All necessary
legislation will therefore be put in place by the end of this
Parliament. The Government will publish a White Paper in spring
2012 setting out further detail on how the recommendations will be
implemented; in advance of that, the Government is open to views
on how to implement these plans.
The Chancellor of the Exchequer, the Rt Hon George Osborne, said:
“The Independent Commission on Banking was set up last year to
look at what I have called the ‘British Dilemma’: how Britain can
be home to one of the world’s leading financial centres without
exposing British taxpayers to the massive costs of those banks failing.
The Government is preparing the most far reaching reforms of
British banking in our modern history - our objective is to make
sure what happened in Britain never happens again.”
The Secretary of State for Business, Innovation and Skills, the
Rt Hon Dr Vince Cable, said:
"Sir John Vickers has produced a comprehensive plan to
give the UK a more stable banking system that removes the implicit
taxpayer subsidy. We will take forward a full programme of reform
with legislation in place to implement the ring-fence by 2015.
"The potential costs of an unsafe banking system are
clear to everyone. Our reforms will protect taxpayers from the
riskier aspects of banking and boost competition without harming
the ability of UK banks to lend, to invest and to compete."
Notes for Editors
1. On 16 June 2010, the Chancellor of the Exchequer and the
Secretary of State for Business announced the creation of the ICB,
to be chaired by Sir John Vickers. The Commission was asked to
consider structural and related non-structural reforms to the UK
banking sector to promote financial stability and competition, and
to make recommendations to the Government by the end of September
2011.
2. The ICB published its report on 12 September 2011,
which can be found here: http://bankingcommission.independent.gov.uk/
3. In welcoming the report, the Government committed to
responding by the end of 2011. The Government’s response can be
found here: http://www.hm-treasury.gov.uk/fin_stability_regreform_icb.htm
4. Today’s response is open for comments until March 2012.
Executive Summary
In its final report the Independent Commission on Banking (ICB)
made recommendations to promote financial stability and
competition in UK banking. It recommended that its reforms be
implemented no later than the start of 2019.
Financial stability
On financial stability, the ICB identified three key objectives:
• make banks better able to absorb losses;
• make it easier and less costly to sort out banks that still get
into trouble; and
• curb incentives for excessive risk-taking.
The ICB recommended a package of measures, consisting of
ring-fencing vital banking services and increasing banks’
loss-absorbency, to achieve these objectives. The Government
strongly supports these objectives and this dual approach.
Ring-fencing
On structural reform, the ICB recommended ring-fencing vital
banking services on which households and SMEs depend, keeping them
separate from wholesale and investment banking activities. This
would more effectively insulate them from problems elsewhere in
the (global) financial system and make banks easier to resolve
without taxpayer support. It would also curtail implicit
government guarantees, reducing the risk to the public finances
and making it less likely that banks will run excessive risks in
the first place.
Improving resolvability of banks through structural reform is in
keeping with international initiatives to make it easier to deal
with failing banks. Structural complexity has been identified by
the Financial Stability Board (FSB) as one of the most important
barriers to successful bank resolution. And a consultation
document on a possible EU framework for bank recovery and
resolution, published by the European Commission earlier this year
, contemplated changes being required to the structure of
financial institutions, so as to reduce complexity in order to
allow critical functions to be separated off in resolution.
The Government agrees with the ICB’s recommendation that vital
banking services – in particular, the taking of retail deposits –
should only be provided by ‘ring-fenced banks’, and that these
banks should be prohibited from undertaking certain investment
banking activities. The Government agrees that structural reform
of the banking sector is needed and supports the proposal for the
creation of a ring-fence around vital banking services.
The ICB set out a number of principles on which the ring-fence
should be based. For example the fence should be flexible in
location but of sufficient height to ensure effective legal,
operational and economic separation between entities. The
Government supports all these principles. Specifically, the
Government intends that:
• There be a set of mandated services within ring-fenced banks
consisting of retail and SME deposits and overdrafts;
• A set of wholesale and investment banking services should be
prohibited from the ring-fenced bank in order to meet the
objectives of the policy;
• The ring-fenced bank should be allowed to conduct ancillary
activities to support the provision of its core functions;
• The ring-fenced bank should be legally and operationally
independent from the rest of its corporate group; and
• Economically the ring-fenced bank should not be dependent for
its liquidity and solvency on the financial health of the rest of
its group.
The ICB set out some further details to support these principles.
For example ring-fenced banks should be regulated for capital and
liquidity purposes on a solo basis, should not be over-reliant on
the rest of the corporate group for funding and should undertake
transactions with the rest of the group on a third party basis.
There is further detailed work to be done to translate the
principles into practice. More details on the ICB’s
recommendations on structural reform, and the Government’s plans
for taking them forward, are set out in Chapter 2. The ICB
recognised that the case for de minimis exemptions to the
ring-fence restrictions was finely balanced, but was not persuaded
at the time. The Government’s view is that there is a case for
reviewing whether a de minimis exemption should apply.
Loss-absorbency
On increased loss-absorbency, the ICB recommended higher equity
requirements for large ring-fenced banks, a minimum leverage
ratio, loss-absorbing debt, insured depositor preference and
higher levels of loss-absorbing capacity for banks that are
difficult to resolve.
Many of these recommendations also fall within the range of
measures contemplated by internationally agreed reforms. The Basel
III rules clearly set minimum, not maximum, standards for equity
and leverage ratios. The FSB’s standards on resolution regimes
require national jurisdictions to make debt loss-absorbing in
resolution (‘bail-in’). And the European
Commission’s
consultation document on a framework for bank recovery and
resolution contemplates both bail-in and requiring institutions
that are hard to resolve to hold more loss-absorbing debt.
The Government supports the ICB’s recommendations on
loss-absorbency and sees these non-structural reforms as an
important complement to ring-fencing in making banks better able
to absorb losses, easier to resolve if they do fail, and in
curbing excessive risk-taking. In particular:
• the Government intends to introduce higher equity requirements
for large ring-fenced banks, and will seek sufficient flexibility
in forthcoming European legislation to do so in the interests of
UK and European financial stability;
• the Government strongly supports a mandatory, minimum leverage
ratio for all banks, as recommended by the ICB, and believes there
may be a case for applying a higher minimum leverage ratio to some
larger banks;
• the Government agrees that the resolution authorities should
have a statutory bail-in power to assist in bank resolution. The
Government will seek to ensure agreement on including a robust
bail-in power in the European crisis management framework;
• the Government supports the principle that systemically
important banks hold a minimum amount of loss-absorbing capacity
on a group-wide basis. However, if a bank can show that its non-UK
operations do not pose a risk to UK financial stability and thus
to the UK taxpayer, this requirement should not apply to those operations;
• on balance, the Government supports depositor preference, but
believes that further analysis and consultation is needed on the
scope of its application; and
• the Government is of the view that supervisors should be able
to require firms that are difficult to resolve to have additional
loss-absorbing capacity.
More details on the ICB’s recommendations on loss-absorbency, and
the Government’s response, are set out in Chapter 3 below.
The ICB’s financial stability recommendations have a clear focus
on preserving the continuous provision of vital banking services
located in the ring-fenced banks. However, it is important to draw
a distinction between protecting the provision of critical
services by ring-fenced banks, and protecting investors. Requiring
ring-fenced banks to have more loss-absorbing capacity will ensure
that the continuous provision of banking activities can be
maintained, if necessary by imposing losses on investors –
including creditors – not by guaranteeing them. The Government’s
view is that all banks should be subject to normal competitive
market forces, which means they must be able to fail safely
without relying on a government guarantee and without putting the
provision of critical services at risk.
The ICB’s proposals – by curbing incentives for excessive
risk-taking, reducing the exposure of ring-fenced banks to the
financial system and requiring non-ring-fenced banks to hold
higher levels of loss-absorbing capacity – will also increase the
resilience, and resolvability, of non-ringfenced banks. This is
crucial. But in order to be effective, this will require the
introduction of a resolution regime for all non-ring-fenced banks,
including any that may not be covered by the Special Resolution
Regime. The Government believes that all banks – including
non-ring-fenced banks – need to be resolvable without the use of
state resources, and believes the ICB’s proposals are an important
step forward. But they should be complemented by the introduction
of a resolution regime that covers investment firms and financial
holding companies. This is discussed in Box 1.A.
Competition
On competition, the ICB made recommendations:
• to improve prospects for a strong and effective challenger to
come out of the Lloyds divestiture;
• to mitigate barriers to entry and anti-competitive prudential requirements;
• to improve switching;
• to enhance transparency;
• to secure pro-competitive financial regulation; and
• on a possible future market investigation reference to the
competition authorities.
The Government strongly supports all these objectives. A
competitive banking sector is vital to ensure that the UK economy
can benefit from banking products and services at efficient
prices. Effective competition is also a spur to innovation and
economic growth, and can lead to better quality and service for
consumers. The emergence of a strong and effective challenger bank
from the Lloyds divestiture – that would exert real, competitive
pressure on the big banks – would be good for competition. A
regulatory focus on improving competition is also consistent with
strengthening the European single market – indeed the European
Banking Authority and other European supervisory authorities are
required to contribute to promoting “equal conditions of
competition”.
The ICB’s recommendations on financial stability will also help
to address competition concerns in financial services, and
complement the competition recommendations. As the ICB noted in
its final report, financial stability recommendations that
eliminate the implicit government guarantee are themselves
pro-competitive. Where banks are regarded as ‘too big to fail’,
market participants – in particular debt investors – will contract
with them on more favourable terms than with smaller banks,
distorting competition. Therefore measures to tackle the implicit
government guarantee will help to remove distortions in the
European single market.
Going beyond the ICB’s recommendations, the Treasury Select
Committee has called for the
Payments Council, a private
sector body responsible for setting the strategy for retail
payment systems in the UK, to be brought within the scope of
regulation. The Government supports this, and will consult in the
New Year on options for enhancing the regulatory framework for
payment systems.
More details on the ICB’s recommendations on competition, and the
Government’s response, are set out in Chapter 4 below.
Economic impact and competitiveness
The ICB estimated that its package of recommendations would cost
the banks £4bn-£7bn a year. The ICB said this could have a
knock-on cost to GDP of around £1bn-£3bn a year, but this should
be set against the benefits of reducing the annualised cost of
financial crises of up to £40bn a year.
The ICB noted that the impact on the Government’s fiscal position
of the reform package would be complex but should be strongly
positive. However, the ICB did not attempt to quantify this. On
competitiveness, the ICB noted that its recommendations would only
affect around 15% of the banking institutions in the City and
would not affect insurance companies, fund management firms etc.
By improving financial stability the recommendations would in fact
be likely to increase the attractiveness of the UK as a place to
do both financial and non-financial business.
The Government has conducted its own economic impact analysis,
informed by modelling exercises carried out by the major UK banks.
On the basis of this work, the Government has concluded that while
the ICB’s estimates do not capture the full range of costs, the
measures that the ICB recommended will deliver net benefits to the
UK economy and the taxpayer.
The Government estimates the aggregate private costs to UK banks
at £3.5bn-£8bn. These additional bank costs are estimated to
produce a gross reduction in GDP of £0.8bn-£1.8bn, somewhat lower
than the ICB’s estimate. Against these costs should be set the
potentially much larger benefits to the economy from increased
financial stability. Based on the ICB’s estimate of the annual
cost to the economy of financial crises, even if other regulatory
reforms reduced the probability of a financial crisis by 30%, and
the ICB’s recommendations reduced the probability of a crisis by
only a further 10%, and the output loss caused by a crisis by 25%,
the ICB’s recommendations would yield an incremental economic
benefit of £9.5bn per annum. The Government therefore believes
that the economic benefits of implementing the ICB’s
recommendations would significantly outweigh the costs and will
deliver significant net benefits to the economy and the public finances.
On competitiveness, the Government is committed to ensuring that
the UK continues to be at the heart of the international banking
and finance sector. This is best achieved by establishing a stable
financial system in the UK, not by providing implicit taxpayer
subsidies to a small proportion of the financial institutions that
constitute the City.
More detail on these issues, including the Government’s own
preliminary analysis of the economic impact and competitive
effects of the ICB’s recommendations, is set out in Chapter 5.
Implementation
The ICB said that its recommendations should be fully in force by
no later than the start of 2019, consistent with the deadline for
implementation of the Basel III reforms agreed by G20 leaders. The
Government's intention is that implementation should
proceed in stages with the final, non structural, changes related
to loss absorbency fully completed by the beginning of 2019.
Primary and secondary legislation related to the ring fence will
be completed by the end of this Parliament in May 2015 and banks
will be expected to be compliant as soon as practically possible
thereafter. The Government will work with the banks to develop a
reasonable transition timetable.
This response sets out the Government’s initial views on the
ICB’s principal recommendations. The Government will bring forward
a White Paper in Spring 2012 which will set out detailed proposals
on the ICB’s recommendations, and launch a consultation.
Implementation of the recommendations will strengthen the
European single market, as one of the biggest distortions to this
market is the perceived implicit government guarantees. The ICB’s
recommendations represent the UK’s contribution to removing these
distortions. The
Government will work to ensure that current
EU legislation does not hinder the reforms necessary to ensure
financial stability and a sound financial system.
More detail on the proposed timeline and mechanics for
implementation – and their interaction with the development of
relevant European legislation – is set out in Chapter 6.
This response contains a number of outstanding policy questions.
The responses to these will be used to inform the detailed
proposals and further consultation that will be set out in the
White Paper. Details on how to respond to the policy questions are
set out in Chapter 6.
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