UK Financial Services Sector Responds to Reforms

The UK banking industry has begun to respond to the Independent Commission on Banking(ICB) interim report into the future framework within which they would have to work if they want to remain headquartered in the UK.

The British Banker's Association (BBA) released a statement on Monday which said it would take time to consider the costs of the recommendations of the ICB and their potential impact on the UK economy.

"The Commission's proposed options will have to be considered alongside other reforms underway at a national and international level. Banks in the UK have already undergone significant change since the global crisis, including significantly increasing their capital and liquidity and establishing resolution plans, to protect depositors and to keep finance flowing, should a bank get into difficulty," the BBA said.

"The UK's regulatory framework is also being dramatically changed with new and welcome focus on financial stability. Banks like any other company must be able to fail and not assume the tax-payer will step in.

"As such, due consideration must be given to where the the ICB's interim recommendations fit within this ongoing programme, some of which remains work in progress, with further changes due before the final report is due," it added.

Meanwhile John Cridland, Director-General of the Confederation of British Industry (CBI), said it was important the ICB's recommendations focused on reform of the banking sector rather than breaking up the banks.

"Stability in the banking sector is best achieved by establishing necessary capital buffers, having effective recovery and resolution arrangements, and appropriate supervision.

"Requiring banks to hold 10 percent capital buffers against their UK retail operations will provide an additional shock absorber in the event of a financial crisis, though we agree with the Commission that this would be best done through international reforms," he added.

"But the Commission's proposals on ring-fencing could have a significant impact on the UK financial landscape, and will need to be carefully assessed to ensure that they allow banks to support businesses and growth, and strengthen this country's position as a leading global financial centre."

Both HSBC and Barclays Bank have yet to respond to the report telling CNBC they were still studying its recommendations and likely impact. Lloyds Banking Group told it expected to release its reaction to the recommnedations later on Monday morning. The banking industry was only given the report 30 minutes before it was published.

Arturo de Frias, Head of Banks Research at Evolution Securities said overall the report had been milder than had been feared but that it did have implications for two of Britain’s largest banks.

He recommended investors sell Barclays shares arguing the cost of ring-fencing its UK retail division would be an issue for the bank. “Furthermore, the broader question of whether Barclays can generate rate of earnings above 10 percent to 11 percent in the mid term still remains,” Frias added.

He also reiterated a “buy” call on Lloyds Banking Group stating the recommendation that the bank close 600 branches had a limited effect on its value.

“The impact on our sum of the parts valuation (SOTP) of a larger disposal is limited: we estimated that, for every additional 100 branches sold, our SOTP would roughly fall by £700 to 800 million, slightly more than 1 percent of the SOTP,” he said.

Professor Philip Booth, editorial director of the Institute of Economic Affairs (IEA) said while some of the report’s recommendations were welcome the ICB focused too heavily on regulatory measures to ensure banks had sufficient capital to prevent failure.

"A competitive market requires banks to fail and their orderly failure should be the key objective of reform. It was also disappointing that the important issue of the over-taxation of equity capital, flagged by the Chairman of the Commission Sir John Vickers in a recent speech, has been side-lined," he added.

Thereport outlined several options for the government to consider that if brought into law would have major ramifications for the banks such as Barclays, HSBC, Standard Chartered and Lloyds Banking Group.

Such is the interest in the ICB's recommendations that it's website was struggling to cope with the level of traffic is was receiving on Monday.

The headlines were widely expected, core capital ratios at 10 percent, curbing incentives for excessive risk taking and making it easier and less costly to sort out banks that get into trouble.

The big news, and the question that still remains unanswered, is on ring fencing of retail banking operations. The ICB is keeping its options open by stating that there are benefits splitting retail and investment banks, but saying that the full benefits of such a move would be lost if there was an complete split.


For those banks like Barclays, which makes the majority of its profits from Barclays Capital, the big question was whether the ICB would push for retail and investment banking operations to be capitalized separately via ‘functional subsidization’.

The better outcome for Barclays would be some kind of ‘operational subsidiarization’ which safeguards payment systems and loans to business in the event of a bank heading for collapse, like RBS did three years ago.

From the report it is not yet clear how draconian this part of the recommendations will be.

Today’s announcement is simply the halfway mark for this process, with the final report not expected until September when the UK government will have to decide whether to implement the findings.

The important thing to remember is that the ICB’s recommendations are just that, recommendations, and the UK chancellor George Osborne can pick and choose from its findings as he sees fit, with one major restriction, public opinion.

If he decides to ignore any of the key rulings, Osborne can expect a rough ride in the UK press and would also add to divisions within the UK coalition governmentas his Liberal Democrat partners push for checks and balances on what they describe as Britain’s ‘Casino banks.’

The second area that the ICB is looking into is UK retail competition. The initial finding that Lloyds Banking Group's divestment program should be ‘substantially accelerated’ makes pretty bad reading for Lloyds following its ill-fated takeover of HBOS at the height of the crisis under pressure from the then prime minister Gordon Brown.

That deal, whilst terrible for shareholder value at the previously risk averse Lloyd’s TSB, was supposed to give the bank a once-in-a-lifetime opportunity to take over a major rival without competition concerns getting in the way.

At the time that was the case, but now, with former CEO Eric Daniels gone, the key selling point of his takeover of HBOS is under threat from the ICB which could force Lloyds to sell off more than the 600 branches it had originally been asked to do.

The message coming from Number 11 Downing Street in recent weeks has been: "Where are they going to go? Is HSBC really going to move to China?"

Does not JP Morgan’s Jamie Dimon say New York Regulation is making his life difficult Mr. Diamond?

As we get closer to the day when George Osborne will have to make his final call expect more bluff from the politicians and the bankers, whether or not either side will actually call the bluff is open to debate.