TEXT-Fitch says ring-fencing could widen ratings gap within bank groups

(The following statement was released by the rating agency)

Oct 10 - Ring-fencing the investment banking or retail banking operations of major European banks could lead to greater ratings differentiation between legal entities in the same banking group, Fitch Ratings says.

While approaches may differ, we think the overall effect would be broadly similar, creating safer retail banking units with more stable and possibly higher credit ratings through economic and market cycles. The UK has already begun steps to ring-fence banks' retail arms, while proposals from a European Commission expert group led by Erkki Liikanen recommend putting up a similar barrier around certain securities trading activities of major universal banks.

The credit profile of the retail arms would be supported by deposit funding and relatively low-risk secured lending. But the credit profiles of parts of a banking group that engage in certain securities trading and investment banking may weaken as they lose funding benefits from retail operations, and because of their fundamentally more volatile earnings and risk profiles.

The extent to which ring-fencing would widen the gap between ratings in the same bank group would depend on its effectiveness at separating the funding and capital of the different businesses, and the detail of what activities will be allowed to form part of a retail banking operation.

It is too early to say how big an impact on ratings ring-fencing would have. Also, these changes would come alongside other major regulatory reforms. In particular, the broader move to reduce the need for future bailouts is likely to reduce the amount of state support we factor into Issuer Default Ratings, while rising capital and liquidity requirements should strengthen banks' credit profiles, benefiting their Viability Ratings.

Although the UK and European ring-fencing models have similar intentions, there is a risk that UK banks would have to ring-fence more than one part of their business if law-makers did not find some common ground. However, the European proposal is only at an early stage and could still change significantly if it is taken forward.

(Caryn Trokie, New York Ratings Unit)

((Caryn.Trokie@thomsonreuters.com; 646-223-6318; Reuters Messaging: rm://caryn.trokie.reuters.com@reuters.net))