House of Commons Treasury Committee
Independent Commission on Banking: Final Report
Written Evidence
Only those submissions written specifically for the Committee for the inquiry into the ICB’s Final Report and accepted as written evidence are included.
List of written evidence
Page 1 Campaign for Community Banking Services 3 2 Finance and Leasing Association 8 3 Unite the Union 10 4 Lloyds Banking Group 14 5 Building Societies Association 21 6 Financial Services Consumer Panel 26 7 ICAEW 33 8 CBI 39 9 Nationwide Building Society 44 10 Consumer Focus 48 11 British Bankers’ Association 56 12 Association of Corporate Treasurers 66 13 Royal Bank of Scotland 72 14 Barclays 74 3
Written evidence submitted by the Campaign for Community Banking Services (CCBS)
EXECUTIVE SUMMARY The ICB declined (8.44) to make any recommendations in the area of branch network access, specifically on neutral shared branches and improvements to IBAAs (inter-bank agency agreements) , recommended by the Treasury Committee to the Commission for consideration as potential solutions to an important barrier to entry and competition in the retail banking market. This submission examines ICB’s flawed and incomplete analysis of IBAAs, neutral shared branches and post office access upon which its ‘no action’ decision was made and suggests there is now an urgent need for government to consider not only the competition problem with regard to branch networks, but also the issue of escalating branch closures in the social contexts of community sustainability, financial inclusion and carbon reduction. We also comment upon ICB’s weak stance on creation of a strong challenger to the established banks, putting too much emphasis on a combination of the ‘Verde’ assortment and the NAB subsidiaries which would result in at least 50% of its branches being in Scotland and the North of England and five cultures to unify whilst being expected to take on the incumbent banks. INTRODUCTION 1. CCBS is a coalition of 20 national charities, consumer and small business organisations which share concerns about the decline in local access to, and choice in, banking services particularly the closure of local bank branches and the impact of this on community sustainability, financial exclusion and carbon emissions. We assist local communities in campaigning against closures and promote viable alternatives including neutral shared branches and inter-bank agency agreements. This submission is made against a background of a 44% reduction in bank branches since 1990 resulting in 1000 communities being left without banking access and a further 1000 with only one bank and therefore no competitive choice for branch dependent individuals and small businesses. The attached bar chart reveals an escalating return to significant closure programmes by the big banks which is continuing in 2011 with an emphasis on the categories identified above. 2. This submission deals exclusively with the Competition aspects of the ICB Final Report and in particular addresses the considerable shortcomings of paragraph 8.44 in which the Commission attempted to justify its decision not to make any recommendations in the area of improvements to inter-bank agency agreements (IBAAs) and neutral shared branches, the absence of which represent important barriers to entry and inter-bank competition. Recognising this, the Treasury Committee had recommended (Competition & Choice in Retail Banking, April 2011) that the ICB consider these solutions within its competition remit.
3. However it should be said that realistic assessment of alternatives to branch access needs to go beyond the benefits to competition, and to the SME sector, and recognise the direct and indirect advantages for vulnerable individuals, community sustainability and carbon reduction, all government priorities. The Treasury Committee has experience of a similar failing as it recommended, in 1996, that the Financial Exclusion Taskforce explore shared branching which it failed to do because of its narrow focus on just the financial inclusion benefits.
4
TREASURY COMMITTEE RECOMMENDATION 1. In its report Competition & Choice in Retail Banking published 2 April 2011, the Committee, having received evidence from several sources, dealt with the need for branch networks as a ‘barrier to access’ in paragraphs 137-139 and specifically recommended, Recommendation 19: “That the ICB considers solutions such as an improved Inter Bank Agency Agreement and neutral shared branches as part of its remit to promote competition in banking”. 2. On 4 April 2011 CCBS wrote to Sir John Vickers with considerable detail in support of the Treasury Committee’s recommendation and offered more. This offer was not taken up.
3. As the Committee’s recommendation was directed specifically at the ICB, the Government’s response of 12 July 2011 did not comment.
GOVERNMENT’S POSITION 1. Since the Election CCBS has corresponded, unsuccessfully, with BIS, C & LG and DEFRA all of whom passed the matter to Treasury without comment.
2. Treasury acknowledged in its replies: “The government believes that it is important to ensure that people can access the banking services they need easily and conveniently” and “understands the importance to local communities of having access to appropriate financial services”
but made it clear that the matter was for the ICB to consider. Regrettably the ICB failed to do so properly.
ICB REPORTS
1. At its own request the ICB was provided initially with the comprehensive evidence on these matters which CCBS had provided to the OFT’s review of Barriers to Entry in Retail Banking but, in its report of 4 November 2010, the OFT commented (page 150): “From the evidence received, this (shared banking facilities) was not a route either existing incumbents or potential entrants expressed interest in as they were reluctant to share space with rivals and dilute their own customer experience” This displays an astonishing absence of challenge on the part of the OFT as the shared branching model, on which they have been repeatedly briefed, is a neutral space operated by outsourcers. The major banks have been briefed on this over many years and new entrants need to understand what could be available to them and how it could meet their needs. CCBS has briefed most new entrants since. The OFT, and the ICB, were made aware of our criticism on 5 November 2010. 2. In its Interim Report the ICB, not having had time to consider the Treasury Committee’s recommendations, acknowledged the need of new entrants to have access to cash (and cheque) handling services and that the Post Office network was not the complete answer. Accordingly it sought responses in its consultation to the question: “How could small banks’ ability to offer a national network of cash handling services be improved?” 5
3. CCBS and others responded, calling for improvements to IBAAs and a shared branching trial, and ICB, in its published summary of responses acknowledged: “There was concern raised about bank branch closures. Respondents suggested that the Post Office might be able to play a fuller role in providing banking services, while others wanted to see more shared banking services.
4. In its Final Report the ICB displayed an astonishing absence of understanding of the well documented shortcomings of IBAAs, the intrinsic neutrality of shared branching and the infrastructure and funding problems of post offices in concluding, at 8.44: “The Commission does not see a clear case for making recommendations in this area”.
5. The operation, cost and level of awareness of IBAAs has been the subject of criticism since the Cruikshank report of 2000 and the Competition Commission’s efforts to achieve provision on “fair, reasonable and non-discriminatory terms” in 2002 were successfully thwarted by the big banks which have consistently failed to honour their commitments to improve a service which can facilitate competition between them and with new entrants. ICB, however, concluded: “The Inter bank agency agreements that already exist offer an adequate mechanism for these services to be provided by large banks to small banks where required”.
6. The definition of neutral shared branching used by CCBS in its submissions to the OFT, the Treasury Committee and ICB is as follows: Basic counter and related services, to agreed operating standards, delivered by third party provider(s) on behalf of participating banks through a variety of delivery channels –retail/social enterprise franchises, mobile vehicles, community banks and banking centres – as appropriate to each community and locality. The model, which uses existing common technology, can replace existing branches and make it cost- effective to establish an ‘open to all’ banking presence in new communities, free from the perceived competitive disadvantages of IBAAs and post offices. Why then did ICB not challenge the mistaken concern of smaller banks that their customers would be targeted by advertising in this neutral environment, especially as the chief executive of one of them, Aldermore, had written in the Daily Mail 25- 4-2011 “Small banks should be allowed, for a sensible price, to use the infrastructure of the big banks. This would allow small businesses to deposit money into their chosen bank anywhere throughout the country. This would act as a real spur to competition.”
7. The ICB puts its faith in “additional planned investment by the Post Office” to put right substantial infrastructure deficiencies of space, security and staffing that, alongside the inherent sales conflict, currently prevent post office outlets providing banking agency services to 90% of the country’s 5 million small businesses. The small business sector is the heaviest user of bank branch counters. Since the shortcomings in post office provision identified by ICB in its Interim Report, there has been no indication that massive government funding is available to improve the post office network to a point where it could handle business banking given that it struggles now to provide consistent quality of service when it is available to less than 10% of the sector. CONCLUSION 1. There is little doubt that the subject of neutral shared branching and improvements to inter-bank agency agreements has not received from the ICB the full consideration expected of it when the Treasury Committee made its recommendation on 2 April. 6
2. Renewed and escalating branch closure activity by the established banks, and the urgent need for new competitors to enter the market with comparable access facilities, demands urgent and thorough consideration by government of all the alternatives available and options for imposing action upon the established banks. The social impacts should also be taken into account. OTHER MATTERS Given the ICB’s confirmation that a strong challenger is required in the retail banking market, it is relevant that a combination of NAB’s UK subsidiaries with the mandated Lloyds’ disposals would result in at least 50% of the new bank’s branches being in Scotland and the North of England; a geographical imbalance that would seriously diminish the competitive strength nationally. The new bank would also face the difficulties of unifying five separate bank cultures whilst being expected to challenge the established banks competitively.
September 2011 7
BIG 4 BANKS NET BRANCH CLOSURES (excluding branch mergers) 2000 - 2010
350 325 300 275 250 225 200 175 150 125 100 75 50 25 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: BBA Annual Abstract of Statistics 2011 and CCBS research
Campaign for Community Banking Services 8
Written evidence submitted by the Finance and Leasing Association (FLA)
Introduction
1. The Finance and Leasing Association (FLA) is the leading trade association for the consumer credit, motor finance, and asset finance sectors. Our members include banks and building societies and their subsidiaries, the finance arms of leading retailers and manufacturing companies, and a range of independent firms.
2. In 2010, FLA members provided £70 billion of new finance to UK businesses and households. £50 billion of this was in the form of consumer credit, including 30% of all unsecured lending in the UK, made available via credit and store cards, unsecured loans, store credit, second charge mortgages, and funding for half of all private new car sales. The remaining £20 billion was provided to private and public sector businesses via leasing and hire purchase. This represented around a quarter of UK fixed capital investment (other than property) during the year, including support for 750,000 small and medium-sized enterprises.
3. We consider the ICB was right to recognise that consumer credit is provided by a wide variety of lenders, including many non-banks. It would not have been sensible to restrict consumer credit provision to ring-fenced banks. Maintaining a healthy and diverse population of lenders - both banks and non-banks - for consumers and SMEs will be an important objective for the Government in its parallel consideration of a new regulatory regime for consumer credit.
4. Similarly, the ICB was also right to allow ring-fenced banks to lend to businesses on a secured basis to avoid limiting competition and choice in the market. It is vital, however, that such lending includes not only loans secured on business assets or the personal assets of directors, but also asset finance where security comes from the bank’s ownership of the asset that is being financed. Realised losses on asset finance are typically very low (less than 1 per cent of outstanding finance) so there should be no problem over allowing ring-fenced banks to lend in this way.
5. Lending to small business could suffer as a consequence of the proposed prohibition on ring-fenced banks’ lending to non-bank financial businesses (p.235 of the report). It is essential not to cut off the supply of finance from ring-fenced banks to the many non- bank business and consumer finance companies. Such lending clearly has no impact whatsoever on the exposure of the ring-fenced banks to global financial markets.
6. Measures that go further than the Basel III requirements accentuate the need for attention to the detail of the impending changes to the capital requirements regime. In particular, we are concerned that the security provided by the asset in asset finance should be properly recognised. The draft changes to the Capital Requirements Directive introduce a new requirement for the value of the asset to be based on a ‘publicly available’ source. Depending on how this requirement is interpreted, there could be a 9
problem here, as many assets are quite specialist. It is critical that sufficient regulatory attention and resource is invested now, to get these details right for all the types of loans that ring-fenced banks will offer.
7. We would be happy to give further evidence to the Treasury Committee on any of the issues we have raised.
23 September 2011
2
10
Written evidence submitted by Unite the Union
This response is submitted by Unite the Union. Unite is the UK’s largest trade union with 1.5 million members across the private and public sectors. The union’s members work in a range of industries including financial services, manufacturing, print, media, construction, transport, local government, education, health and not for profit sectors.
Unite is the largest trade union in the finance sector representing some 150,000 workers in all grades and all occupations, not only in the major English and Scottish banks, but also in investment banks, the Bank of England, insurance companies, building societies, finance houses and business services companies.
Executive Summary
Due to the short response timescale, this response will focus on the issue of remuneration and the effect the financial crisis has had on workers in the finance sector.
• Unite has expressed disappointment at the outcome of the ICB final report and, in particular, some key omissions, including calling for a change to remuneration and reward systems, as well as recommending changes to the culture and behaviour in the boardroom that encourages greed. Unite believes that this is a lost opportunity for a new order of socially useful and ethically robust banking.
• Unite is also concerned that additional costs will be introduced affecting customers through increased charges, and that the workforce, through a reduction in jobs, will suffer as the banking sector seeks to claw back additional costs that will be incurred as a result of creating the firewall between retail and investment banking across the industry.
Introduction
1. Unite is disappointed that there has been little acknowledgement of the effect the crisis has had on those employed in the banking industry. It is estimated that around 150,000 finance sector jobs have been lost since the beginning of the crisis as a result of acquisitions, mergers, and, ultimately, financial and corporate mismanagement. This has led to an increase in the pace and intensity of work, rising stress levels and lower morale among the workforce, which when combined with concerns over job security, adds further pressures to an already intense working environment.
2. Unite is further concerned that the drive to increase profits to compensate for the eventual costs associated with ring-fencing will be paid for by the workforce through lower pay, further job losses and pressures to increase sales targets; and on to customers through increased charges and higher interest rates on borrowing and lower interest rates on savings.
11
3. The ICB were in a position to recommend fundamental changes to the way banks are run. Ultimately this requires a cultural and behavioural shift. However, the ICB pulled back from recommending a move towards a more ethical and socially responsible banking system, instead focused on ring-fencing against the existing risk driven behaviours which pervade the industry. Unite sees this as a fundamental failure in the report.
Remuneration
4. The ICB failed to tackle the issues associated with the remuneration systems which operate within the banking sector. Unite has made representations to the ICB and others1 that there must be an assessment of the role of remuneration and reward and the part it played in the banking crisis and how this must be reformed in order to limit the risk of such a crisis taking place in the future.
5. Many of the reward packages within the finance sector link pay and performance, with the majority linked to sales. The stress placed upon workers in the industry to reach personal and peer group targets is recognised as a significant contributory factor leading to behaviour which may lead to inappropriate selling taking place as well as higher levels of sickness absence and an increase in the number of workers involved in the disciplinary process on grounds of performance.
6. Unite is disappointed that the ICB has also failed to address the link between target based reward systems and the increase in complaints to the Financial Ombudsman Service (FOS), a significant number of which are due to inappropriate sales including Personal Protection Insurance (PPI). 2
7. The ICB was tasked in its Terms of Reference with “ensuring that the needs of banks’ customers and clients are efficiently served”. 3 The reward system should therefore have been considered if this statement is to be addressed. All aspects of remuneration systems must be transparent, accountable, and fair and open to independent scrutiny. They should not be sales driven.
8. The Which? Future of Banking report published in 2010 agrees. It stated that:
“There should be no commission or bonuses received for selling products.” 4
9. According to the Which? report sales based remuneration systems should be replaced by reward schemes which focus on customer satisfaction, fair treatment and resolution of customer complaints.
10. Unite believes that the adoption of an ethics based culture within the boardroom and filtered down through the company would have improved customer
1 Unite responses to HM Treasury, FSA, Treasury Select Committee between 2008 and 2011 2 FOS Annual Report 2010/2011 3 http://www.hm-treasury.gov.uk/d/banking_commission_terms_of_reference.pdf 4 Which? Future of Banking Commission Report 2010 Para 25 12
confidence, raised morale among the workforce and improved existing negative perceptions of the industry.
Culture and behaviour
11. Unite is disappointed that the ICB failed to recommend a socially useful banking business model which incorporates a moral and ethical dimension; one which regards good customer service as important as its drive for sales; one that is fair in its treatment of its workforce as well as treating its customers fairly, and one which will serve the needs of society and not just a mechanism for delivering profits at any price.
12. Unite would wish to re-emphasise the points made in our response to the ICB interim report regarding corporate governance.
Weak corporate governance has been identified as a key determinant which led to the crisis and yet the existing system of corporate management and company law remains relatively unchanged. The Treasury Committee Ninth Report of the Session 2008-2009 identified that the Board of Directors (Executive and Non-Executive) have a duty to promote the success of the company. The Report went on to refer to a comment by John Varley (Group Chief Executive of Barclays Bank) to the Committee that banks were the “single, biggest contributor” to the crisis. The Report also included a quote from the Pensions and Investment Research Consultancy (PIRC) who recognised that the Board approved the “business strategies and products that caused such damage…” and they urged the committee to consider the role of the boards. 5
Indeed the previous Chancellor, Alistair Darling, in his evidence to the Committee stated that the board of directors was an “area which we overlook at our peril.” The ICB has overlooked the role of the Board in this process. 6
13. Much of the responsibility for the crisis could be said to lie firmly on the shoulders of the Board of Directors in the banking sector and yet the ICB has decided not to take decisive action to ensure that the boards conduct themselves in a manner which is conducive with good corporate behaviour, social responsibility and which incorporates ethically sound judgements. This could have included tough penalties or legal action which would act as disincentives for risky behaviour. The ICB failed to take a clear stand to encourage a change in corporate culture.
5 http://www.publications.parliament.uk/pa/cm200809/cmselect/cmtreasy/519/519.pdf Para 128 6 http://bankingcommission.independent.gov.uk/interimresponses/ 13
Conclusion
14. The workforce in the banking sector have seen the media portray them, by association, as “greedy bankers” 7; customers have taken their anger for the crisis out on them; 8 their employers are making their colleagues redundant 9 and regulators and the Financial Ombudsman are scrutinising every aspect of their work. It is little wonder Unite members are feeling battered and bruised and more than a little annoyed.
15. It is therefore disappointing that in the most important review of the banking system in a generation those who will ultimately be responsible for turning around the industry were not given any acknowledgment for the contribution they make to the industry, or recognition of the pressures placed upon them throughout the upheaval of the past four years.
September 2011
7 Daily Mail: 15th May 2009, The Sun: 26th April 2010, Sunday Mirror: 13th February 2011 8 Mail Online: “Bank workers given alarms to deal with public anger.” 28th September 2009 9 More than 60,000 jobs have been lost within Royal Bank of Scotland and Lloyds Banking Group since 2008. 14
Written evidence submitted by Lloyds Banking Group
Executive Summary
Lloyds Banking Group (‘the Group’) welcomes this opportunity to provide our first impressions of the Independent Commission on Banking’s (ICB) final report to the Treasury Select Committee (TSC).
FINANCIAL STABILITY We are broadly supportive of the ICB’s recommendations on ring-fencing and also welcome the Commission’s support for making capital buffers truly loss-absorbing. Given the complexity of the issues in the report, however, our comments below are necessarily high-level.
COMPETITION We believe the UK retail banking market is internationally competitive but we also think more can be done to enhance competition and have led the way in putting forward proposals for achieving this. We therefore welcome the ICB’s recommendation that the new seven-day switching process which we proposed and the Payments Council has adopted be implemented swiftly, in tandem with measures to increase transparency and comparability.
We believe that the Verde process will lead to the emergence a strong and effective competitor and we believe that the divested bank is well placed to benefit from the opportunities that enhanced switching and transparency will bring. Our view is that the combination of the Verde divestment and the switching and transparency measures will be transformational while it needs to be recognised that they should be given the necessary time to take effect. On this basis a potential review by the Office of Fair Trading (OFT) in 2015 seems appropriate.
FINANCIAL STABILITY
1. FINANCIAL STABILITY
1.1 RING FENCING We support ring fencing key UK banking activities within universal banks as a way to contribute to the objectives of eliminating or significantly reducing subsidies, improving resolvability and safeguarding key economic functions.
Width
We welcome the ICB’s recognition of the importance of a wide ring fence for safeguarding the provision of credit to the economy, which is key to minimise the economic consequences of banking crises. As we had argued in our response to the ICB’s Interim Report, even the largest companies that normally have access to capital markets 15
rely on the provision of credit by banks in a crisis, when capital markets become impaired. Furthermore, large companies rely on bank credit facilities and deposits in normal times as well in order to demonstrate the liquidity necessary to achieve the rating required for capital market issuance. we therefore fully support the ICB’s recommendation to allow lending to corporates of all sizes to be included within the ring-fenced bank.
Height
In terms of the ‘height’ of the fence, we support the ICB’s recommendation to allow the use of a holding company structure which would continue to allow different activities to be part of a single group.
On governance, it must be emphasised that the UK’s main banks are by no means homogeneous and therefore a ‘one size fits all’ model of governance may produce unintended and unwelcome consequences. In the Group’s case, for example, there would be no conflict of interest between the ring-fenced bank and the Group as a whole and therefore no benefit from having separate Boards.
1.2 CAPITAL In conjunction with the ICB’s recommended structural ring-fencing reforms, the enhanced capital requirements recommended in the ICB’s report make UK banks much less likely to require taxpayer support. Ring-fenced banks, in particular, will be exceedingly safe entities, protected from the volatility and interconnectedness of the I- bank.
Loss absorbing capacity of capital
We welcome the ICB’s stated intent that the proposed enhancements to capital requirements should be loss absorbing, since loss absorbing capital facilitates the continuity of credit in a downturn.
The ICB correctly recognises making buffers loss absorbing can be difficult, since in practice loss absorbency depends on the market’s reaction to a bank’s dipping into a buffer. We welcome the ICB’s useful suggestion in this regard, namely that authorities allow buffers to be used in meeting stress test requirements.
We also welcome the ICB’s recognition of the need to allow banks some flexibility in implementing proposals to increase loss absorbing capacity (e.g. equity capital, non- equity capital and bail-in bonds). In particular, we are pleased that the ICB is allowing contingent capital to form part of a bank’s loss-absorbing capacity.
Impact on cost of funding
Depositor preference is likely to have a significant impact on the cost of unsecured debt and will thus encourage banks to make greater use of secured funding where possible. It will likely also have an impact on the price and availability of credit to households and businesses.
16
It is unclear what the impact on funding costs and availability will be of requiring that all senior unsecured term debt can be bailed in. A consistent international approach to the structure of bail-in as a concept would help to minimise unintended consequences.
1.3 RESOLVABILITY In the event of a crisis it should be possible for failed banks to exit the market in an orderly fashion without jeopardising the provision of key economic functions. This allows the competitive process to function without adversely affecting financial stability and eliminates any potential for moral hazard arising from possible implicit guarantees to a bank.
We are fully engaged with the Bank of England and the FSA in developing a credible living will. With regard to the ICB’s recommendation that regulators be allowed to impose an additional 3% capital buffer (a ‘resolution buffer’), we would note that the potential factors that can be considered in determining the amount of any applicable buffer are vague and allow considerable regulatory discretion and risk of super- equivalence. We would encourage the Government to clarify these factors in primary legislation.
1.4 TRANSITION PERIOD With regard to the length of the transition period for the ICB’s recommendations, we believe that a long transition period for both enhanced capital requirements and structural reform is particularly important so as to avoid potential damage to the economic recovery. As ring fencing also involves significant technological and legal complexities, a long transition period will also be needed to allow banks time to minimise the cost of adjustment. We fully support the ICB’s recommendation to allow banks until 2019 to complete these changes.
COMPETITION
2. COMPETITION
2.1 SWITCHING IN PCAS AND BCAS We believe the UK retail banking market is competitive compared to other international markets. Customers change provider much more frequently in the UK market and often use more than one bank, a market feature more common in the UK than in other markets. However, as we said to the ICB, we also think more can be done to enhance competition.
Customers want easy-to-understand products, clear information about charges and benefits so they can compare different providers, and the ability to change provider easily and quickly if they want to. We therefore welcome the ICB’s recommendation that the new seven-day switching process which we proposed and the Payments Council has adopted be implemented swiftly. The Payments Council is now actively working on the implementation of a fully automated, guaranteed system to enable customers to switch current accounts within seven days. Indeed it is working on enhancing existing services during 2012 in time for full implementation of the transformed solution by September 17
2013. We are confident that the ICB’s deadline of September 2013 will be met – more details can be found at http://www.paymentscouncil.org.uk/media_centre/press_releases/-/page/1618/.
The TSC may be aware that the Payments Council met with HM Treasury (HMT) and agreed that the CEO’s of all Payments Council banks would each write to Mark Hoban by 30 September pledging their commitment to implement the switching solution. We have done this and the letter is attached at Annex 1.
This is the right thing to do for customers and good for competition. Customers should be able to understand, compare and switch product providers if they are dissatisfied or indeed a better offer comes on the market – it is that understanding and capability that enhances competition.
2.2 THE NEED FOR STRONG REGULATORY SUPPORT FOR THE SWITCHING SOLUTION We outlined to the ICB the need for strong regulatory support for the switching solution. Experience from other industries and countries suggest that strong regulatory support will improve the outcomes delivered by the switching solution. The regulator needs to ensure that all providers are ready to launch the service and prevent implementation moving at the pace of the slowest. The scheme needs to be marketed by a trusted, independent body and the relevant industry regulator (Ofgem and Ofcom) took on this role when switching was introduced in energy and telecoms to make sure customers were aware of the new service. The regulator also needs to survey customers regularly for a period after implementation to make sure there is good customer awareness and that customers who use the service find it easy and hassle-free.
We would also support an industry code of practice covering all of the obligations on current account providers and direct debit (DD) originators to make the scheme work effectively. This could cover:
‐ Clear and consistent marketing: rules on displaying and promoting the service ‐ Free use for customers: banks should not be allowed to charge for the service ‐ Rules for banks: ensuring that banks don’t limit access to the switching service. ‐ Rules for direct debit originators: appropriate incentives (or penalties) for DD originators to ensure timely updating of their records ‐ Rules guaranteeing the service for customers: switching to be guaranteed so that customers to not suffer loss if mistakes occur
The Regulator’s role would comprise: ‐ Oversight: is the service being delivered? Progress monitoring of development plans via regular updates; is it working? Performance monitoring of switching via regular management information ‐ Enforcement: taking a firm line with banks and DD originators who do not deliver ‐ Continuous evaluation: customer survey prior to implementation and periodically after implementation to enable robust evaluation of costs and benefits. ‐ Oversight: the Regulator should ensure that all banks introduce the service simultaneously. 18
The customer survey work we have done (Quadrangle survey previously provided to the TSC and ICB) indicates a favourable response by consumers to the new switching proposition along with strong indications of potential for increased switching activity; 66% of consumers surveyed say it would make switching easier, 51% say it would make them more likely to switch if they needed to and 64% say it would make the industry more competitive. Customers also said that for the service to work properly it was important that the service was independently regulated.
2.3 TRANSPARENCY Our view is that in tandem with the measures that have been recommended on switching, transparency needs to be improved in order to allow customers to understand and compare the cost of their current account with the other offerings available. We support the ICB’s recommendation to improve transparency by putting interest forgone on current account statements. While this is not a panacea it is clearly a meaningful first step in the direction of providing improved clarity.
Improving comparison websites is the next step.
These websites don’t work as well as in other markets where switching is common. For energy and phones, websites show customers the total cost of different providers based on the customer’s pattern of use and show providers’ customer service ratings alongside price comparisons. Regulators have introduced codes of practice for the comparison websites to make sure they offer independent, reliable and meaningful comparisons. For current accounts, these websites currently only offer customers limited information on the total cost of current accounts with the only available comparators being credit and overdraft rates or the benefits (such as travel insurance) offered by accounts with monthly fees. They don’t allow customers to understand the cost of a current account based on typical patterns of usage. They do not even rank according to best rate/price even within simple these simple categories and accounts at the top of the list often reflect commissions paid to the comparison website. They are also solely price focussed – there is no ability to search by quality and range of service. This is often as important to customers as price when choosing a current account.
As we have said to the ICB, the Group is willing to work with the Financial Conduct Authority (FCA), Money Advice Service, Which? and other consumer groups and the switching websites to better develop more ‘meaningful’ Personal Current Account comparison tools and we are talking to these organisations to improve the tools available to customers to make more meaningful comparisons.
2.4 FCA We think that there is a risk that regulatory rules applying in the banking sector may operate as barriers to entry, growth, or competition, and therefore we think that the new FCA should have a duty to have regard to the objective of promoting competition, among other policy considerations, when exercising its functions. We do not consider that the FCA should have concurrent powers with the OFT to enforce general competition law. 19
2.5 VERDE We are pleased to note that the ICB has not recommended that Lloyds Banking Group dispose of further branches. Instead it has focused on the emergence of a strong new challenger, by reference to funding and market position in PCAs. We believe that the Verde process will lead to the emergence of such a strong and effective competitor and we believe that the divested bank is well placed to benefit from the opportunities that enhanced switching and transparency will bring. While we understand the ICB’s desire to use market share as a proxy for how competition in the PCA market is working we think that this is looking at the symptom rather than the cause. Our view is that while this market is competitive more can be done and that the best means of stimulating further competition is to focus on robust switching and transparency remedies, which the ICB has recommended in its report and which we are now working to implement. Improved switching and transparency in other markets have demonstrated that these remedies can drive significant results.
The ICB has chosen a number of criteria by reference to which they think the OFT should assess the state of the market in 2015 – obviously if the OFT conducts such a review, the conditions of competition will be a matter for it to assess as it thinks fit. Our view is that the combination of the Verde divestment and the switching and transparency measures will be transformational while it needs to be recognised that they should be given the necessary time to take effect.
September 2011 20
ANNEX 1: CEO Letter to HMT pledging our commitment to Switching solution
21 Written evidence submitted by the Building Societies Association
Executive Summary
• The Building Societies Association (BSA) broadly welcomes the proposals made in the Independent Commission on Banking (ICB) Final Report. The structural reforms, together with other reforms that are in train, should reduce the Government subsidy that large complex banking groups have enjoyed, enabling mutual lenders and deposit takers to compete on a more equal basis.
• The proposed structural reforms recognise that building societies can be the model for a more sustainable and socially useful retail financial services sector. The principles of risk management that are appropriate within the ring-fence are modelled on legislation which has applied to building societies for a number of decades. As such, ring-fencing should have only a marginal effect on mutuals’ businesses. Principles such as these would have limited some firms’ reliance on short-term wholesale funding which contributed to their failure in the financial crisis.
• Furthermore, mutuals are already well capitalised, with Core Tier 1 ratios above the minimum recommended by the ICB. It is sensible that the ICB proposes a sliding scale so that the largest, most complex firms are most affected by the higher capital requirements.
• However, the backstop leverage ratio may discriminate against firms such as retail- funded mutual lenders which have high volumes of low risk assets. And requiring debt to be subject to bail-in at such retail-funded firms means that write-downs will be concentrated among a relatively small group of wholesale creditors. These reforms therefore risk having perverse effects on mutuals.
• The BSA believes that a case remains to increase the divesture of branches by Lloyds Banking Group, and that financial education to increase financial capability could potentially do more to help to improve consumer outcomes in the current account market than changes to the switching process.
• Having a diverse range of providers in terms of size, geography, business model and approach to risk management can help to make the retail financial services sector more stable and increase competition and choice. The Coalition Agreement stated a desire to promote mutuals and foster diversity, and although recognised only implicitly in the ICB report, its recommendations should help to achieve this goal.
Introduction
1. The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK, including all 48 UK building societies. Mutual lenders and deposit takers have total assets of over £365 billion and, together with their subsidiaries, hold residential mortgages of almost £235 billion, 19% of the total outstanding in the UK. They hold more than £245 billion of retail deposits, accounting for 22% of all such deposits in the UK. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.
2. As the ICB states, at present, “an expectation of government bail-outs means the price of bank funding does not reflect the risks that banks run” [Paragraph 3.95 of the Independent Commission on Banking (ICB) Final Report]. The proposed structural reforms should help to remedy this, and result in a more stable and competitive market in the future. The BSA believes that, broadly speaking, the proposals made by the ICB are a vote of confidence in the UK building22 society model, which has provided security and good returns to UK consumers over many years and across the economic cycle.
Retail ring-fence
3. The ICB’s proposals for ring-fencing retail activities in its own subsidiary will help to reduce the impact of a bank failing, make it easier for the authorities to resolve a bank, and by doing so, reduce the incentive for banks to take excessive risks as wholesale creditors are more exposed to losses. The retail ring-fence proposed by the ICB insulates the activities (principally depositing, borrowing and transmitting money) that matter to consumers and businesses, services which they could not easily obtain elsewhere. In concert with other regulatory developments, this reform should help to ensure continuity of supply of these services, even when one of these retail financial service providers fails. And structural rules such as the retail ring-fence are likely to be more difficult to erode than regulatory standards.
4. A key reason that the BSA supports the ring-fence idea is that it should help to reduce the Government subsidy to large, complex, systemic banks. The Commission estimates that the value of these subsidies considerably exceed £10 billion a year. By making these complex banks easier to resolve, creditors are less likely to assume that the firm will be supported by the taxpayer if it runs into problems. Such implicit (and explicit) guarantees have meant that large complex banks benefitted from cheaper sources of funding than many mutuals, which has distorted the markets and made it much more difficult for some mutuals to compete. The ring-fence should mean that firms are competing on a fairer basis to provide financial services to households and businesses, and mutual lenders and deposit takers are looking forward to competing on equal terms with other ring-fenced entities.
5. The ring-fence design, as proposed, should have a limited impact on mutual lenders and deposit takers. This is perhaps unsurprising, as mutuals did not cause the financial crisis, and instead are seen as the model for the solution by the ICB. The ICB states:
“The precedent in building society legislation appears to provide a particularly good basis for the risk management functions of ring-fenced banks. Building society regulations have operated effectively for a long time. A number of former building societies failed in the crisis or were taken over as a result of poor business models, sometimes associated with their treasury-related activities. However, evidence to the Commission suggested that problems that occurred in the treasury function only did so following the lifting of the relevant restrictions after demutualisation. In principle a ring-fenced bank should be able to undertake its necessary risk management within the building society regulatory framework, although the types of permitted instruments might need some extending given the wider range of services which may be provided by ring-fenced banks.” [Paragraph 3.53]
6. However, while broadly welcoming the ICB's proposals, we also need to look carefully at a few areas at the margins where there may be one or two respectable activities that are permitted under existing building societies legislation that appear to be ruled out by the ring-fence. For example, a building society must be the head of its corporate group and is prohibited from being a subsidiary of a parent company, so it could not utilise the holding company or operating company models proposed by the ICB. And the principles for the ring-fence state that any entities owned or partly owned by a ring-fenced bank can conduct only permitted activities. Therefore, if a building society conducted any activities not permitted in the ring-fence it would not be able to organise its activities into ring-fenced and non-ring-fenced23 subsidiaries; it would have to discontinue or divest these prohibited activities.
7. Retail banks do take risks, and the BSA therefore welcomes as one of the principles that the ICB sets out for the retail ring-fence the inclusion of ancillary services such as the use of interest rate derivates to hedge and manage these risks. As the ICB states, “in general, it would be damaging for financial stability to hamper the effective operations of the treasury function” [Paragraph 3.51]. Such ancillary activities are vital to ensure that ring fenced subsidiaries would be able to operate on a standalone basis, thereby making them easier to separate and increasing the credibility that investment banking activities will not be bailed out.
8. Other activities that are central to modern retail banking activities, such as raising wholesale funding and managing liquidity are also permitted within the ring-fence. It is sensible to permit ring-fenced entities to transact with other ring-fenced entities, as well as non-ring-fenced banks, in order to conduct necessary treasury activities. And it is appropriate that the ring-fenced operations should have to meet regulatory requirements in relation to liquidity, capital, etc, on a standalone basis. A key recommendation in this area that many commentators appear to have overlooked, however, is that the ICB proposes that “back-stop limits should be placed on the proportion of a ring-fenced bank’s funding which is permitted to be wholesale funding” [Paragraph 3.57]. When it ran into problems, Northern Rock had obtained over 75% of its funding from wholesale markets. A limit on wholesale funding could have prevented this excessive behaviour. The Building Societies Act limits this to 50% of funding, and the average proportion of wholesale funding at building societies peaked at just under 30% in the run up to the crisis, and is now at just over 25%.
9. It is vital that the ring-fence is effective, and that ring-fenced and non-ring-fenced entities that are legally separate are also separate in substance, so that they are not reliant on the parent company. The principle proposed by the ICB that economic links to the parent group are no more substantial than those with third parties should help to enforce this boundary.
10. Protection must be put in place to ensure that the reforms do not result in such volumes of business flowing to non-ring-fenced entities to such an extent that they themselves become systemically important. It is important that the authorities credibly signal that large, interconnected wholesale and investment banks will be allowed to fail in order for them to be subject to increased monitoring and diligence by creditors and counterparties. In the BSA submission to the ICB’s Interim Report, we called for the Government to impose some sort of statutory commitment on itself not to rescue banks outside the ring-fence. Once it has been given a few years to bed in, the operation of the ring-fence should be reviewed, and this review should assess how much activity is taking place in entities outside the ring-fence, and whether these entities could realistically be allowed to fail.
11. The ICB rightly acknowledges that there need to be important cultural differences between the retail ring-fenced bank and investment banking operations. They propose that a ring-fenced subsidiary should have its own board of directors, the majority of which are independent non-executives, and that there is minimal cross-over between the directors on the group board and that of the ring-fence. This again reflects what has been required of building societies for very many years, and as set out in the FSA Handbook of Rules and Guidance which states that the Chair should not hold an executive position, and that a clear majority24 of directors on a society's board should be non-executive1.
12. For large universal banks operating across the ring-fence recovery and resolution plans will be vital to ensure the retail subsidiary can be separated on resolution. However, for small, simple institutions the costs of developing detailed resolution plans are likely to outweigh the benefits, especially as standard insolvency procedures under the UK’s Recovery and Resolution Regime will be sufficient, as was shown to be the case in the resolution of the Dunfermline Building Society in 2009.
Capital and loss absorbing debt
13. Under the ICB’s proposals for ring-fenced firms’ capital requirements, it is sensible that a sliding scale is used so that it is the largest firms, whose failure would have the largest impact, which are affected the most by the proposed minimum capital requirements. Presently, the largest mutual lenders and deposit takers have an average Core Tier 1 capital ratio of 12.7%, well above the ICB (and therefore Basel III) minimum, so the ICB proposal should not have an immediate effect on mutuals.
14. Some of the concerns that we raised in our submission to the ICB in relation to the non-risk adjusted leverage ratio remain unaddressed. The ICB recommends that all ring-fenced banks should maintain a Tier 1 leverage ratio of at least 3%, as in Basel III, and up to 4.06% for larger institutions. However, this requirement could have perverse effects as it discriminates against low risk, high volume business models, such as retail- funded mortgage lenders, potentially hindering these institutions’ ability to lend.
15. In our submission to the ICB’s Interim Report we recognised the value of contingent and bail-in debt for the largest, complex, systemic banks. The ICB’s Final Report recommends that, at resolution, bail-in can be applied to instruments issued by all institutions2. We believe applying this to all firms risks imposing a disproportionate cost on non-systemic firms, for little benefit in terms of financial stability. In particular, at predominantly retail-funded institutions, bail-in would be concentrated among a small group of wholesale investors, necessitating large write-downs. This may have a perverse effect on these firms’ ability to raise wholesale funding.
16. We support the proposal for retail depositor preference for insured deposits, while also recognising that there could be benefits for consumers if this were extended so that all genuine retail deposits were preferred. We would also reiterate our suggestion to the ICB that any changes to the creditor hierarchy to place insured retail depositors above other creditors should be planned and communicated carefully to avoid distortions and unintended consequences in funding markets, and that the transition to the final position should be swift and apply universally and simultaneously to all firms. Otherwise this change could cause potential disruptions in funding markets if the relative position of creditors in the hierarchy changes at different times for different firms.
Competition
17. The BSA believes that Lloyds Banking Group will retain considerable market power even after the divesture required by the European Commission. We are therefore disappointed that the ICB has decided not to press for an additional divestment of
1 FSA Handbook: Building Societies Regulatory Guidance, BSOG 1.3.9G 2 This power applies to all instruments, in the first instance, with a term of 12 months or more at issuance, with secondary powers to impose losses on all other unsecured debt. The ICB proposes no grandfathering of existing instruments. branches, but we accept that the experience25 with the Verde divesture has shown how difficult it is to realise this sale in current market conditions.
18. The BSA believes the switching process for personal current accounts should be transparent and reliable, and the ICB makes recommendations aimed at improving the process, including redirecting direct debits, and the Payments Council is introducing changes accommodating these recommendations. However, the BSA is not entirely convinced that such reforms will lead to considerable increases in current account switching or consumer benefit. This is because much consumer survey evidence indicates that most consumers are satisfied with their current account. We recommended a full cost benefit analysis to ensure that the reforms would deliver the hoped-for benefits. Efforts to increase financial capability might be more fruitful in increasing consumers’ awareness of the advantages to them of switching accounts.
19. The ICB also recommends the FCA be made a pro-competitive regulator, with a primary duty to promote competition and greater powers to police this. The BSA believes that the FCA should promote competition, including due consideration of the effects of regulations on mutual providers, but that it is not clear why retail banking is special to the extent that the existing designated competition authorities are not sufficient in applying competition and consumer law to the sector.
20. Finally, the ICB does not explicitly recognise in its report the benefits of having a diverse range of providers in financial services markets, except in that the performance of universal banks and investment banks are more closely correlated to the market as a whole than are retail banks, and therefore adding these operations to a retail bank might increase, rather than decrease, systemic risk. The Government, in its Coalition Agreement, stated its desire “to foster diversity and promote mutuals in financial services”. This is something on which the Treasury Committee has previously called the Government to do more to deliver3. Diversity, for example in ownership structures, is important because firms will then face different incentives and will not all behave in similar ways, and are thus less likely be affected by a system-wide shock in the same way. Diversity therefore increases the resilience of the system, as well as benefitting consumers by providing greater competition and choice.
21. We therefore welcome the ICB’s proposed structural reforms in that they should prevent complex, systemic banks from enjoying Government subsidies, enabling other types of provider to compete on an equal basis, and welcome the Commission’s acknowledgement of the value of the mutual and building society sector’s way of doing business in providing sustainable and socially useful retail financial services.
September 2011
3 Treasury Committee, 2011, Competition And Choice In Retail Banking
26
Written evidence submitted by the Financial Services Consumer Panel
Introduction
In our submission to the Independent Commission on Banking1 we set out a number of key consumer outcomes which the banking sector should deliver for consumers. We welcomed the ICB’s interim report2, particularly the proposals aimed at promoting a market that provided choice and value for money, which we thought went a long way towards meeting these key outcomes. The interim report supported our view that the regulator needed competition powers, as well as an effective toolkit and resources to deliver consumer protection in banking and to ensure access to financial services. The ICB report cannot be considered in isolation, but in the context of wider national and international regulatory change.
It is now time to establish whether, along with the new regulatory structure in the UK and international initiatives, the ICB recommendations will deliver what is needed. We are pleased that Members of Treasury Committee have decided to hold an evidence session with the Commissioners and we have set out in this submission the key issues for retail consumers that we believe need to be addressed, and that we would like Committee Members to take into account during their cross-examination of the Commissioners.
Executive summary
The Panel’s engagement with the Independent Commission on Banking has focused on the interests of retail consumers, including small businesses, and the impact of wider reforms and changes such as the split of future regulatory responsibility between the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). The Panel is not in a position to undertake a detailed analysis of some aspects of the Commission’s recommendations, such as the economic impact of the ring-fencing proposals, but we have taken the opportunity to set out in this submission the key consumer issues that we would like the Committee to take into consideration in their cross-examination of the Commissioners. These issues fall into three main areas.
• Competition. We fully support the Commission’s overall approach to competition issues and we agree that the new FCA should have a specific competition objective. We have also reiterated our recommendation that the FCA should be the lead on competition issues in financial services, including dealing with supercomplaints and referring competition issues to the Office of Fair Trading (OFT)/Competition Commission only when structural changes may be needed. We support recommendations to improve current account switching, and would like some of the detail of the methodology explored further. Consumers will only move their accounts when there is a more diverse range of services and providers on offer, however, and when more meaningful information is provided by banks about the products and services they offer, how they will meet key
1 At www.fs-cp.org.uk, November 2010 2 At bankingcommission.independent.gov.uk, April 2011. The Panel’s response is at www.fs-cp.org.uk, July 2011 27
consumer needs, and how much they cost. We would be interested to learn whether the Commissioners think that the divestiture of Lloyds Banking Group could be dealt with more creatively, using further enhancements or restrictions to ensure increased competition within the retail banking market. We welcome the recommendation that the PRA and OFT should review the application of prudential standards to ensure that they do not present an unnecessary barrier to entry to the banking sector, or an impediment to growth. This is an issue we would like to see debated further.
• Protection. We strongly support measures that will ensure the safety of retail deposits and avoid further costs to the taxpayer as a result of bank failures. We do not however have the technical expertise to express an opinion on whether the proposed ring-fencing arrangement would be the most effective way to deliver the necessary degree of safety, and will rely on others to undertake that assessment. We would be interested in learning more about how any ring-fencing or similar arrangement would work for the retail end user, where there could be complexities of detail, such as consumer access to fixed rate mortgages. We agree with the Commission’s recommendations for “insured” depositor preference in the event of bank failure, but would welcome clarification of the position of retail depositors whose accounts would not fall within the scope of the Financial Services Compensation Scheme – such as consumers with aggregate savings with retail banks operating under a single authorisation that exceed the limit of £85,000.
• Timing. We accept that there is a great deal to be debated and agreed before the proposed deadline for change of 2019, although in our view significant progress could be made now on issues such as greater transparency. Nevertheless 2019 is over seven years away and retail consumers and tax-payers remain vulnerable to uncertainty in the financial markets. We would be interested in the views of the Commissioners and of the Committee on any transitional changes that should be put in place ahead of 2019.
Effective competition and real choice
Effective competition
1. The reform of the banking industry, alongside regulatory and other changes already underway, must bring effective competition, end unfair charges and drive up standards of service. Bank accounts are an essential part of life and it is vital that consumers get a fair deal from organisations they should be able to trust. A well functioning and competitive market that delivers the right outcomes for consumers will also deliver a sustainable and less risky business for the retail banking industry as a whole. Well-managed, competitive banks operating in a well-regulated sector where banks focus on good ongoing customer service should be an achievable goal.
28
Choice
2. Part II of the ICB Report covers competition issues. We fully support the Commission’s overall approach – what is important is not competition in the abstract but competition to provide what consumers want. With this in mind, we are encouraged by the Commission’s recommendations to improve current account switching – and we are pleased to see that the Payments Council is already committed to working in this area3. The Panel has long supported account number portability and we suggest that the Committee might usefully explore whether the alternative suggested by the Commission – an ‘alias database’ – will achieve the same result. Improvements to the switching process are important; however, consumers will be more inclined to switch accounts if there is a service available that is better, cheaper, or both and at present they see little difference between what banks offer4.
3. The Commission’s view is that a substantial enhancement of the Lloyds Bank Group divestiture is the best opportunity to improve the structure of the personal current account market, with the focus on ensuring the emergence of a strong new challenger. Of course this is an important area and the Commission is proposing enhancements to the process, including the transfer of retail deposits along with branches to ensure that a purchaser is able to operate effectively. Further enhancements or restrictions may be necessary to prevent this divestment merely strengthening one of the other major banks and not increasing competition within the retail banking market and we would welcome further debate in this area.
Transparency
4. In order to shop around consumers need access to information about the products and services that are available and how much they cost. We agree with and support the recommendations in the report on improving transparency, although we see no reason why banks and the regulators could not start work on this now. We too would like to see information such as credit interest forgone made available on account statements in a standardised form and we welcome the ICB’s support for improving price comparison tools for personal current accounts. If banks providing retail banking services opt to change their current business models this may well result in the illusion of “free banking” being dispelled. But we see nothing in the ICB recommendations themselves that would inevitably mean that banks could not offer a no-charge-if-in-credit option on a menu of current account services and facilities, if they wished to do so. Consumers may welcome this outcome.
5. Banks’ obligations under the Payment Services Directive5 make it clear that the charges they can impose for payment services must be proportionate to the actual costs relating to that customer. So banks should already have
3 Press release “Payments Council Board endorses plans to make account switching easier” 15 September 2011 at www.paymentscouncil.org.uk 4 Stick or Twist, Consumer Focus, October 2010 at www.consumerfocus.org.uk 5 Regulation 54 29
made considerable progress in identifying the cost of particular services to customers and being in a position to justify and disclose that cost in this particular context. We do not think it is much of a leap for banks to start providing far more information to their customers about the price of/charges for operating a bank account and any ancillary products and services that customers might want to use. This could include a summary statement of total charges for each customer. A format similar to the Moneymadeclear tables6 could provide a useful template, to be used alongside best practice/qualitative type guides produced by independent bodies.
6. The Panel also welcomes the work being done by the European Banking Industry Committee to improve transparency of bank charging at EU level, although it believes nevertheless that there is room for further improvement. The Report itself refers to the work of FairBanking7 in this context and we think this approach is worth further consideration.
Impact of Regulation
7. The role of the new conduct regulator, the FCA, is another key factor in invigorating competition in the banking sector. As we have said during the continuing debate on the future of regulation we believe the FCA should have an objective to promote effective competition that improves consumer outcomes in retail and wholesale markets. Section 1B(4) of the draft Financial Services Bill requires the FCA only to discharge its general functions in a way which promotes competition, when this is compatible with its other objectives. The ICB suggests replacing the ‘efficiency and choice’ objective with a specific ‘promoting effective competition’ objective. The Panel has suggested changing the wording of this objective to ‘efficiency, access and choice’. We would be interested to learn from the Commissioners how their proposal might encompass these concepts in its single ‘promoting effective competition’ objective. It is not simply a question of the FCA’s statutory powers and duties however. The FCA will need an effective toolkit and the right resources with which to carry out its functions if the right outcomes are to be delivered in practice.
8. The case for the FCA to have concurrent powers, as do other industry regulators, to use its expertise to carry out market investigations, with reference to the Competition Commission only if structural change needs to be considered, is a strong one. The FCA should be the lead on competition issues in financial services and should refer competition issues to the OFT/ Competition Commission when rules cannot be made to solve a problem and structural changes may be needed. It should also deal with supercomplaints regarding banking and other financial services. Support from the Commission and the Committee for this approach would be invaluable.
9. There is reference in the ICB recommendations to barriers to entry to the market and suggests that the new PRA should work with the OFT to review the application of prudential standards to ensure they do not unnecessarily
6 At moneyadviceservice.org.uk 7 Fairbanking Foundation at www.fairbanking.org.uk 30
limit the ability of new entrants to grow. We welcome this as an area for further analysis and debate. Obviously we would not wish to see consumers’ interests put at risk by new banks with business models unable to withstand economic pressures in the rush to provide a more diverse market, but we are concerned that the PRA in particular may focus on prudential issues to the detriment of competition. For this reason we believe that as well as working with the OFT, the PRA’s objectives should include an obligation to have regard to the impact of its actions on competition. We also think the FCA and PRA should consider ways of speeding up the authorisation process, while maintaining its robustness. This would take a measure of uncertainty and costly ‘waiting time’ out of the procedure.
Protection
10. One of the most radical proposals in the ICB Report is to require a ring-fence around particular retail business activities8. This approach has immediate appeal, particularly in the light of recent media coverage of substantial financial losses to one bank apparently caused by a single employee9.
11. We strongly support measures that will ensure the safety of retail deposits and avoid further costs to the taxpayer as a result of bank failures (plus any other benefits to consumers of stability). There has been much discussion of the additional cost of such an arrangement – and there seems to be no doubt that any such move would involve costs to all parties – perhaps with a view to discrediting the proposal. The Panel does not, however, have the technical expertise to evaluate the specific ICB recommendations and we will be relying on others to undertake this work. Nevertheless we believe that it is essential that further measures are taken to protect consumers and tax- payers from future bank collapses. The onus is on the critics of ‘ring-fencing’ to propose an alternative that delivers better protection for retail and small business customers and gets the tax payer off the hook, at lower cost. If the consensus following the Treasury Committee Review and further consultation is that ring-fencing as proposed is the most effective way to deliver the necessary outcomes, we would be happy to support the ICB approach.
12. We believe that the application of the ring-fence principles set out in the ICB Report, whatever the mechanism that is eventually identified, should go a considerable way towards ensuring the right level of consumer protection. But the feasibility of the approach will very much depend on the detail of ring-fenced operations at customer level. Some of this is referred to in the Report, such as where banks wish to offer customers fixed rate mortgages, which would involve the use of a derivative product. This immediately raises questions about the complexities of applying the ICB principles in practice and we are interested in learning more about how any ring-fencing structure might work for the end retail user.
13. We support the ICB’s recommendations for “insured” depositor preference as a further level of consumer protection. This would place most retail
8 Chapter 3 of the Report 9 Statement 16 September 2011 at www.fsa.gov.uk, report 18 September at www.bbc.co.uk/news/business 31
depositors ahead of other creditors, such as holders of other forms of bank debt. Importantly, in real terms this would shift the immediate risk currently borne by the Financial Services Compensation Scheme (FSCS) onto market counterparties. This should encourage share and bond holders to take greater responsibility for the behaviour of banks.
14. We are not sure of the position of retail depositors whose accounts fall outside the scope of FSCS cover. This might include, for example, individuals with deposits with more than one bank within a group whose total savings exceed the current protection limit of £85,000. These would not be “insured” deposits as we understand the position described in the Report, yet it seems inequitable that they should not enjoy the same retail depositor preference as an individual whose savings total, say, £84,000. This again is an area which will benefit from further clarification and detailed debate.
Timing
15. There are a great many important principles and practicalities to be debated before the ICB’s recommendations, or proposals developed from the recommendations, can be put in place. Nevertheless 2019 is over seven years away, and we are living in an environment dominated by global financial uncertainty. Retail consumers as well as tax-payers continue to be vulnerable.
16. The banking industry is also making other changes and will have to respond to national, European and other international initiatives in future. We would like to see the industry taking the initiative and working alongside consumer groups and the regulators to bring about some of the changes recommended in the Report much more quickly. For example, greater transparency over retail banking services and charges could we think be an area where significant progress could be made in a relatively short time.
17. While we do not have specific proposals on any transitional protections for retail customers, we would be interested to hear the views of the Commissioners on any areas covered in their Report where transitional protection might be necessary, or where there is a significant risk of additional detriment before reforms are put in place. As already indicated we do however think that progress could be made now in areas such as greater information about fees and charges.
Annex: about the Financial Services Consumer Panel
The Panel is an independent statutory body, set up to represent the interests of consumers in the development of policy for the regulation of financial services. It works to advise and challenge the FSA from the earliest stages of its policy development to ensure they take into account the consumer interest.
The Panel also takes a keen interest in broader issues for consumers in financial services where it believes it can help achieve beneficial change/outcomes for consumers. 32
Since the Panel was established in 1998, we believe it has helped deliver significant, positive benefits for consumers. We support the FSA where we believe policies can help consumers and challenge the FSA forcefully when we feel consumers would be disadvantaged.
Members of the Panel are recruited through a process of open competition and encompass a broad range of relevant expertise and experience.
There are fifteen members of the Consumer Panel, including the Chair Adam Phillips and Vice Chair Kay Blair. Current members have experience of consumer advice, campaigning, communications, market research, journalism, the law, financial services industry, financial inclusion, European issues, financial regulation and compliance and later life issues.
30 September 2011
33
Written evidence submitted by the Institute of Chartered Accountants in England and Wales
INTRODUCTION 1. We are writing in response to the call for evidence by the Treasury Committee on the final report of the Independent Commission on Banking (ICB). Our submission is concerned with the proposal to create ring-fenced retail banks. ICAEW would be pleased to provide oral evidence on any aspect of its evidence. We also stand ready to provide further technical input to the Committee.
2. The ICB’s ring-fencing proposals are multi-faceted and complex. The evidence below reflects ICAEW’s current understanding of the main issues, but further questions may surface as public debate proceeds.
WHO WE ARE 3. ICAEW operates under a Royal Charter, working in the public interest. Its regulation of its members, in particular its responsibilities in respect of auditors, is overseen by the Financial Reporting Council. As a world leading professional accountancy body, we provide leadership and practical support to over 136,000 members in more than 160 countries, working with governments, regulators and industry in order to ensure the highest standards are maintained. We are a founding member of the Global Accounting Alliance with over 775,000 members worldwide.
4. Our members provide financial knowledge and guidance based on the highest technical and ethical standards. They are trained to challenge people and organisations to think and act differently, to provide clarity and rigour, and so help create and sustain prosperity. We ensure these skills are constantly developed, recognised and valued.
5. ICAEW established a Financial Services Faculty in 2007 to be a world class centre for thought leadership on issues and challenges facing the financial services industry, acting in the public interest and free from vested interests. It draws together professionals from across the financial services industry and from the 25,000 ICAEW members in the sector, including those working for regulated firms, in professional services firms, intermediaries and regulators.
MAJOR POINTS Ring-fencing 6. Following full consultation with stakeholders, the Government will need to make a high-stakes judgement call in striking a balance between public demand for strong action against the concerns of the banking industry and others about the possible costs and unintended consequences of such action. It is important that Government sets a clear direction and timetable for any further reform. Business confidence requires as much certainty as possible, and any on-going speculation and delay could undermine the economy.
34
7. ICAEW supports the policy objectives of minimising the likelihood of disruption to the supply of vital banking services to the UK economy, and of limiting perceptions of a government guarantee for bank liabilities.
8. We agree with the ICB that ring-fencing would reduce the likelihood of UK retail business being brought down by problems elsewhere in a banking group. It would in general also make it easier to avoid systemic financial disruption to the UK economy in a crisis, because at least some functions critical to the economy would be in separately-capitalised entities. Furthermore, placing functions vital to the UK economy in ring-fenced entities could make it easier for stakeholders to discern banks’ performance in supporting British business and households.
9. So overall we have sympathy for the ICB’s view that essential UK banking services should be kept separate from the wider, global role of some British banks, and in particular recognise the case for seeking to insulate UK retail deposits from capital market volatility. However, there is a range of practical issues which need to be explored further before concluding that ring-fencing is the appropriate path to take.
Suggested questions for Committee 10. We believe that there are a number of important questions that should be considered by the Committee. We have set these out below, and provide some analysis of them in the section on practical issues.
• How do the ICB proposals fit with international developments? • To what extent would the ring-fencing proposals limit the pressures for public sector solvency support to the banking system? • Why does the ICB propose an apparently narrow set of banking services which must be inside the ring-fence? Are there not many more banking services which are essential, and on the ICB’s reasoning should also be inside the ring-fence? • What does the ICB expect the balance sheet position and profitability of ring- fenced banks to be? • How much work did the ICB do on the impact on bank lending, including lending to SMEs, of ring-fencing and the reform programme more generally? • What would be the role of independent boards of UK ring-fenced bank subsidiaries? • Did the ICB consider the implications for transparency of UK ring-fenced banks possibly not meeting the technical criteria for consolidation into the accounts of their wider group?
PRACTICAL ISSUES FOR FURTHER CONSIDERATION International and European developments How do the ICB proposals fit with international developments?
11. In our view the ICB’s proposals need to be considered more explicitly in the context of the global and European financial reform process generally. For example, the current draft of the legal text which would implement Basel III in Europe takes a broadly maximum harmonisation approach to bank capital requirements. That could 35
limit the scope for the UK to impose additional requirements in respect of ring- fenced banks.
12. Another potential constraint is the impact of additional UK requirements on the competitiveness of UK retail banks. There is a risk of ‘passported in’ banks from elsewhere in the European Economic Area gaining market share as a result of less onerous regulatory requirements. At an extreme, this could lead to a repeat of the scenario seen recently with respect to Icelandic banks. This issue was explored in The Turner Review (Box 1 C, page 38).
Public sector support to banking To what extent would the ring-fencing proposals limit the pressures for public sector solvency support to the banking system?
13. Four aspects of the ICB’s proposals relevant to pressures for public sector solvency support of the banking system may require further consideration.
14. First, in our view, the ICB has looked more at the position of banks taken individually rather than instances where much or all of the banking system as a whole is under stress, either domestically or internationally. It may be more difficult to avoid support if the system generally is in difficulties, because that would typically limit the feasibility of private sector options for bank recovery or resolution.
15. Second, the fact that certain banking functions are deemed essential, and required to be placed inside the ring-fence, could create a strong expectation of back-stop public support for ring-fenced banks. This matters because such banks would face a variety of banking risks – for example risks arising from limited diversification of assets and, on the funding side, any imbalances between the deposits they attract and the size of their loan book.
16. We note that the ICB makes a distinction between essential functions, that need to be maintained, and the creditors of banks supplying these functions who, except for insured depositors, in its view do not need to be kept whole. We believe that in a generalised crisis it may be difficult to maintain such a distinction. We also note that for many years the Building Societies Commission administered a kind of ‘UK retail bank’ regime for the societies, and there were nevertheless several cases in which individual societies got into difficulty.
17. These points suggest that there should be the greatest possible commitment ex ante to treating ring-fenced banks in the same way as all other banks with regard to recovery and resolution.
18. Third, the ICB’s recommendations mean that a range of more or less essential functions may be found outside the ring-fence. That could result in pressures to support non ring-fenced business. We do not agree with the ICB that the only truly essential services are retail and SME deposits and overdrafts. For example, deposits of companies above the SME thresholds (many of which are nonetheless relatively small), key forms of credit creation (notably residential mortgages), and vanilla 36
commercial banking services such as trade finance would all normally be regarded as essential.
19. While we accept that in practice banks may voluntarily put many of the business lines identified immediately above inside the ring-fence, because of the need for retail deposits to be profitably invested, this is an area which requires further analysis. It would seem more consistent with the logic of the ICB’s approach to require all functions essential to the UK economy to be inside the ring-fence. The Treasury Committee may wish to review the list of economic functions of banks set out in the recent FSA paper on Recovery and Resolution Plans (CP11/16, August 2011, page 36) and consider whether the set of activities which must be placed inside the ring-fence should be broader than the ICB advocates.
Why does the ICB propose an apparently narrow set of banking services which must be inside the ring-fence? Are there not many more banking services which are essential, and on the ICB’s reasoning should also be inside the ring-fence?
20. Fourth, continuing contingent public support for non ring-fenced banks may arise from the scale, complexity and cross-border nature of the wholesale capital markets business of major banks. As the Financial Stability Board, Bank of England and the FSA have recently indicated, it is questionable whether, for the foreseeable future, there would be a smooth path to resolution without some kind of public intervention – especially if market conditions were highly stressed.
21. There is a variety of work-streams in train internationally, in Europe and domestically on Recovery and Resolution Plans (RRPs). ICAEW believes that the ICB Commissioners should make clearer why, if robust RRPs were in place, there would still be a case for ring-fencing – in other words, to justify their view that structural change of the kind the ICB advocates is required in order for RRPs to operate effectively. This is partly a question of whether there would still be a case for the ICB’s proposal that large retail banks hold capital in excess of the Basel III minima, and for their proposals on bail-in-able debt that go well beyond what has been agreed globally (if so, there would have to be separately-capitalised entities to which these additional requirements would apply).
Banks’ business models What does the ICB expect the balance sheet position and profitability of ring-fenced banks to be?
22. The ICB report does not explicitly analyse the implications of the regulatory reforms for banks’ business models, and the extent to which the proposals are consistent with a banking system that works for both banks and bank customers. In particular, there is a need to look at what the business position (both profitability and balance sheet) of ring-fenced banks might be – especially the interest margins that might be needed for such banks to be economically viable. This analysis should be done against the backdrop of a range of medium-term macro-economic scenarios, including ones in which economic growth remains subdued for an extended period of years.
37
23. A key issue is whether the synergies for firms and customers from the universal banking model can be largely retained, as the ICB maintains, in a ring-fenced model where retail and wholesale banking are still in the same group.
How much work did the ICB do on the impact on bank lending, including lending to SMEs, of ring-fencing and the reform programme more generally?
24. There are at present a variety of pressures on banks’ income and return on equity. These include existing domestic and international initiatives to increase capital and liquidity requirements, the implications of fragile economic conditions on the value of their assets, and a strengthening of the regulatory framework for conduct of retail business. In this environment, market appetite to absorb new issuance of bank equity or debt at anything like current levels may well be limited. There is a risk that banks’ reaction to further tightening of prudential requirements will be to restrict lending, and/or widen spreads.
Governance, accounting, insolvency and other legal issues 25. The ICB proposes that a ring-fenced UK retail bank would be legally, economically and operationally separate from the rest of its banking group. It would have an independent board, should publicly report as if it were an independent listed company, and retail depositors should rank ahead of certain other creditors in the event of insolvency. This raises some important governance, accounting and insolvency questions.
What would be the role of independent boards of UK ring-fenced bank subsidiaries?
26. On the assumption that the publicly-issued shares are those in the bank group, the boards of both the ring-fenced and non-ring-fenced parts of a banking group would be reporting to the same shareholders. It is not entirely clear whether the independent boards of UK retail bank subsidiaries would have an additional duty of care in law to anyone else – but if so the UK bank could conceivably come to operate in a way which was inconsistent with the business strategy of its wider group.
27. We are not sure whether UK retail banks boards would need to be ‘independent’ in the manner envisaged. An alternative would be to retain normal corporate governance arrangements, but for additional duties on the directors of ring-fenced banks to be imposed by statute or regulatory rules. Existing company law can require directors of a subsidiary to put the obligations of that entity before the interests of the wider group – for example, limiting dividend distributions to the parent in instances of a pension scheme deficit.
Did the ICB consider the implications for transparency of UK ring-fenced banks possibly not meeting the technical criteria for consolidation into the accounts of their wider group?
28. Regarding accounting, if the retail subsidiary bank was strongly separate in the way the ICB envisages, there could be important technical complications regarding the 38
group accounts – it is not clear that the subsidiary would pass the test of control for accounting consolidation (as set out in International Financial Reporting Standard 10: Consolidated Financial Statements).
29. This means that although it may be widely acknowledged that economically the ring-fenced banks are part of wider banking groups, it might not be possible to reflect this in banks’ group accounts.
30. The proposal to move depositors up the insolvency rankings could have a significant business impact. Insolvency law is a complex area, so any legislation would need careful consideration. It could indeed have the effect of incentivising wholesale markets to pay closer attention to the risks run by banks and strengthen the role of market discipline. However, the effective subordination of wholesale creditors could make it more difficult for banks to obtain market funding whenever confidence is fragile.
31. Alternatively, markets might seek to protect their position by carrying out a higher proportion of transactions with banks on a collateralised basis – in which case there would little impact on market discipline.
32. The ICB report lists legal issues which would need to be addressed in any transition to ring fencing, in the light of legal advice taken by the ICB (paras 5.98-5.99, p150). This list looks formidable, and to facilitate Parliamentary and public consideration the substantive legal advice should be put in the public domain.
CONCLUSION 33. There is a considerable number of issues regarding design and transition which will require further consideration in order to see whether ring-fencing would make a positive contribution towards the public policy objectives in the ICB’s mandate.
34. The benefits of any form of ring fencing that may be proposed by the Government would need to be carefully compared to the costs. More generally, the need for financial stability and protecting future taxpayers has to be weighed against the needs of businesses and customers to have financial services available at an affordable price, and the important role that financial services play in the UK economy.
35. The ICB has provided extensive analysis. It will take time fully to consider the report and the questions it raises. As the report is debated, some of the issues highlighted above may be resolved, while others may come to light. We would be very happy to assist the Committee further in any aspect of its work in considering the ICB’s proposals.
30 September 2011
39
Written evidence submitted by the CBI
The CBI perspective
1. The CBI is the UK's leading business organisation, speaking for some 240,000 businesses that together employ around a third of the private sector workforce.
2. Our contribution to the Independent Banking Commission, and submission to the Treasury Select Committee inquiry, focuses on the “business user” view of the banking system and the impact of potential reforms on business.
3. The CBI’s membership encompasses companies of all sizes and sectors, including banks, so we are uniquely well placed to do this.
Executive summary
4. Business wants greater stability in the banking sector, but the immediate need is for an unrelenting focus on bank lending to support the economic recovery and growth.
5. The ICB recommendations will add to the cost of banking operations in the UK, all of which will have some impact on the cost and availability of lending to business.
6. Against a backdrop of major reform to the financial sector, the “when” and “how” details for implementing the ICB’s recommendations need careful examination to avoid damage to the economy.
7. Ring-fencing requirements will make bank products more expensive and harder to access for some businesses, and there could be unintended consequences around the stability benefits.
8. Imposing higher capital requirements on UK banks in isolation will make lending to UK businesses more expensive relative to their international competitors.
9. Measures to boost competition in the banking sector are welcome, and will benefit small businesses as well as retail consumers.
Business wants greater stability in the banking sector, but the immediate need is for an unrelenting focus on bank lending to support the economic recovery and growth…
10. UK businesses and the wider economy depend on a strong and stable banking system to conduct everyday business, such as making payments and taking deposits, but also to provide funds for investment and to help manage the risks they encounter in day-to-day trading. Businesses also benefit from a universal banking model so that they can easily access the full range of services they need.
11. The costs of the recent banking crisis have had widespread economic impact, and business wants to see reform in the banking sector. In particular, the CBI favours banks being required to hold more capital to withstand losses, having recovery and resolution plans to resolve crisis situations, and more rigorous regulation to identify and tackle emerging problems. 40
12. Businesses recognise that some of these reforms come at a cost, but these costs must be proportionate to the benefits they deliver in terms of greater stability and competition in the banking sector.
13. With the economy in a fragile state, and bank lending remaining subdued due to depressed demand and constrained supply for parts of the economy, the immediate focus should be on ensuring banks are in a good position to support the recovery, through lending to businesses and consumers. So we urge the Government not to implement any reforms now that would jeopardise that priority.
The ICB recommendations will add to the cost of banking operations in the UK, all of which will have some impact on the cost and availability of lending to business…
14. The ICB proposals will add to the cost of banking operations in a number of ways, which will have a knock-on impact on the cost and availability of lending to business. We set out the detail of this in the sections on ring-fencing and capital reforms below, but in summary:
• The ring-fencing proposals could add to cost in a number of ways:
o Through increasing total capital and liquidity requirements on banks, which both restricts and adds to the cost of lending
o Making it more expensive, especially for small firms, to access some financial services such as treasury products – including foreign exchange, interest rate and commodity hedging – if those activities sit outside the ring-fence
o By banks passing on the costs of ring-fencing, such as loss of diversified earnings, to end customers including business
• The proposals on additional capital – principally for bank activities inside the ring- fence, although measures on primary loss-absorbing capital will impact on non-ring- fenced activities as well – will lead to an increase in the cost of banking.
Against a backdrop of major reform to the financial sector, the “when” and “how” details for implementing the ICB’s recommendations need careful examination to avoid damage to the economy…
15. The CBI believes it is particularly important that the ICB’s suggested approach on the level of flexibility around its ring-fencing proposals and the timing for when the package of reforms will be introduced are maintained.
16. There is already a major programme of international banking reform underway, and much has already changed since 2008. Measures include much tougher capital and liquidity requirements, better recovery and resolution tools or “living wills”, and a tougher and more intrusive regulatory regime.
17. In the UK, for example, banks’ capital buffers are now broadly double what they were in the run-up to the financial crisis, having increased from 4-6% to 9-11% today.
18. All of these will make the banking system more resilient, but the consequence will be to add cost to banking operations. The capital proposals, in particular, will make lending more challenging. 41
19. The ICB proposals are a substantial set of measures that go beyond this programme of reforms that has been agreed internationally. Reforms that are unilateral and add to the cost of doing business should not be introduced at this point in the economic cycle.
20. The CBI welcomes the ICB’s proposals for a phased introduction on the majority of its proposals. First, because the economy should be more resilient and better placed to absorb additional costs. And second, because the 2019 deadline is consistent with when other major international reforms, particularly the Basel III capital reforms, are due to be completed.
Ring-fencing requirements will make bank products more expensive and harder to access for some businesses, and there could be unintended consequences around the stability benefits…
21. The costs of imposing a retail ring-fence on banks will result in some bank products and services becoming more expensive and harder to access for businesses.
22. The ring-fence will increase the total capital and liquidity requirements on banks in total, as capital and liquidity will become “trapped” within each silo of the ring-fenced and non- ring-fenced parts of the bank. This will both restrict and add to the cost of lending, which at least in part will inevitably be passed on to customers.
23. There are some specific prohibitions on what can be inside or outside the ring-fence that could have cost and availability implications for business. These include:
• The ability of firms to obtain risk management products
The ICB proposals specifically prohibit “structuring, arranging or executing derivatives transactions, as agent or principal”. This will make it more costly and harder to obtain for businesses, especially smaller firms, to access some important financial services such as exchange rate hedging and other risk management products.
Restrictions on dealing with non-EEA customers
The ICB also proposes that ring-fenced banks will be prohibited from transacting with entities based outside the European Economic Area (EEA). This has a number of consequences for business. As an example, the following scenarios would not be permitted:
o A small manufacturing business has an operation in Jersey, and wishes this subsidiary to use the same bank relationship
o A medium-sized retail business has outlets in a number of overseas territories, including a number in the US and Japan, but wishes to maintain a single banking relationship in the UK
24. There are also a number of potential unintended consequences that the Government should avoid in implementing the ring-fencing proposals, which could undermine the stated objective of delivering greater financial stability. These include:
• A ring-fence could result in increased leverage in the system, as a result of a mis-match of eligible assets and liabilities within the ring-fence
42 • Moral hazard could increase within the ring-fence, leading to riskier lending practices, driven by a perception that deposits held at the ring-fenced bank will be safe
25. So the CBI urges the Government to undertake a rigorous cost-benefit analysis of the ICB’s ring-fencing proposals to ensure that the costs to the economy are fully understood, and the benefits stand scrutiny, before moving ahead with implementation.
26. The level of flexibility in the design of the ring-fence proposed by the ICB is a step in the right direction, and will go some way to alleviating our earlier concerns expressed at the time of the ICB’s interim report. For example, the proposed design of the ring-fence will allow banks to transact with businesses of all sizes and help prevent distortions in the corporate banking market. It also recognises and allows for different bank business models, which will help to promote competition.
Imposing higher capital requirements on UK banks in isolation will make lending to UK businesses more expensive relative to their international competitors…
27. Requiring banks to hold more and better quality capital is one of the CBI’s preferred measures to help make the banking system more resilient.
28. International reforms, driven by the Basel III proposals and due to be implemented in Europe through the latest Capital Requirements Directive (CRD IV), will significantly raise the levels of capital banks are required to hold to withstand future shocks.
29. The ICB has recommended a package of capital reforms that go beyond the international consensus. These include requirements for higher levels of capital within the ring-fenced bank, a minimum level of primary loss-absorbing capital at the group level, a higher leverage ratio and new proposal to introduce depositor preference. Depending on how they are interpreted and implemented, the new proposals on primary loss-absorbing capital could be particularly significant.
Notwithstanding the benefits of enhanced financial stability, capital reforms will lead to an increase in cost. This will impact on business in one or both of the following ways:
• Imposing higher equity capital requirements, coupled with making debt funding riskier for investors, will increase the overall cost of funds for banks. This will ultimately get passed on to customers.
• Banks may look to reduce their levels of lending to stay within the new capital requirements, as raising further capital in the current market environment will be challenging and costly.
30. The CBI’s concern is that if the UK acts in isolation on tougher capital requirements, the cost of lending to UK businesses will increase, putting UK firms at a disadvantage relative to their international competitors.
Measures to boost competition in the banking sector are welcome, and will benefit small businesses as well as retail consumers…
31. Business wants choice and diversity in financial products, so the ICB is right to set out measures to inject greater competition in the banking sector. These include proposals on switching, price transparency and competition objectives for the new Financial Conduct Authority (FCA).
43 32. From a business perspective, we believe the ICB’s competition proposals will be most relevant to small businesses.
33. The ICB’s proposals to improve switching are welcome and will help to increase competition for small businesses as well as retail consumers. In particular, the CBI supports the recommendation that banks should improve the process for transferring security, which will help businesses that have borrowing relationships with their existing bank. Although little detail on this is provided in the ICB report, we believe this is a critical part of enabling higher levels of account switching for small businesses.
34. The ICB makes a number of proposals in relation to greater price transparency for retail products, including business bank accounts. In general, transparency can help small businesses make informed choices, although we believe that providing data on “foregone interest” will only have a limited impact for many businesses.
35. The CBI also supports strengthening the objectives of the new FCA to ensure that there are strong pro-competitive powers and duties embedded within the new approach to financial regulation. We believe that a markets-based competition approach will deliver better outcomes than the new regulator attempting to impose price controls or acting as an economic regulator.
September 2011 44
Written evidence submitted by Nationwide Building Society
1. Nationwide welcomes the opportunity to provide a written submission on the final report of the Independent Commission on Banking (ICB) to the Committee. This short note provides an overview of our initial position on the ICB’s proposals and suggests a number of specific issues that the Committee should raise with Commissioners.
2. Overview of Nationwide’s position on the ICB recommendations
2.1 The financial crisis exposed weaknesses in the global financial system and came at a very high cost. We therefore welcome the work that the ICB has undertaken in developing a reform package to improve stability and competition in UK financial services.
2.2 We support the core proposal of creating a retail ring-fence as an appropriate measure and the recognition that the building society model should be used, in part, in designing the ring-fence is welcome.
2.3 Nationwide has been operating under ring-fence-type conditions for many years and we have shown that ring-fencing and a competitive, growing and secure business are not mutually exclusive. Unlike our plc competitors, we will face minimal restructuring costs.
2.4 Whilst we are broadly supportive of the ICB’s proposals, there are a number of important aspects that the Committee should look to raise with Commissioners and urge the Government to address:
A leverage ratio over and above Basel III is wholly inappropriate for low- risk institutions and could create significant unintended consequences for consumers and the wider economy.
As considerable reforms are made to improve stability and competition, the time is right for building society law to be modernised, enabling societies to compete effectively whilst retaining their fundamental purpose.
We support the ICB’s proposal for depositor preference – but it should apply to all depositors, not just those with less than £85,000.
More competition in retail banking is welcome but costs of enhancing switching should not outweigh consumer benefits – simpler solutions should also be considered.
3. A leverage ratio over and above Basel III is wholly inappropriate for low-risk institutions and could create significant unintended consequences for consumers and the wider economy 45
3.1 We understand the ICB’s desire to impose higher capital requirements and loss absorbency measures on financial institutions. We were pleased that the final report recognised the current restrictions mutuals have in raising external capital (which we hope will be resolved as the Capital Requirements Directive is finalised) and, therefore, our ability to meet the more stringent requirements set by the ICB.
3.2 The ICB proposes that all ring-fenced banks should maintain a tier one leverage ratio of between 3% and 4.06%, depending on the relative size of their risk-weighted assets to UK GDP. Given Nationwide’s scale, we are likely to be subject to the ratio at 4.06%.
3.3 Whilst we understand the principle behind the measure, the imposition of a leverage ratio – and one significantly higher than set under Basel III – pays no heed to the nature of our business model and the low risk posed by our balance sheet.1 Indeed, we are restricted by statute in our ability to engage in high-risk activity.
3.4 In its current state, the proposal may lead to the unintended consequences of institutions such as Nationwide having to either reduce the scale of low-risk lending and/or increase the proportion of higher risk assets to generate higher returns. This would be contrary to our low-risk approach and affect the safety and security represented by our business model by requiring us to have a higher risk profile on our balance sheet. It may also result in a higher cost of lending to low-risk borrowers and more difficulties in consumers accessing credit. We believe it is more appropriate for leverage to be monitored as part of the supervisory regime, both at individual firm and macro-prudential levels.
4. As considerable reforms are made to improve stability and competition, the time is right for building society law to be modernised, enabling societies to compete effectively whilst retaining their fundamental purpose
4.1 The ring-fence proposed by the ICB is relatively wide and flexible, based upon definitions of ‘mandated services’ that must be ring-fenced (deposit-taking from, and overdraft provision to, individuals and SMEs), a broad range of ‘permitted activities’ that may be inside or outside the ring-fence and ‘prohibited activities’ that must be outside the ring-fence.
4.2 Under the ICB’s proposals, banks will have a significant degree of freedom to determine what goes inside and outside the ring-fence, and to manipulate their balance sheets to optimise capital. Building societies will remain distinct, and rightly so, from ring-fenced banks as they will continue to operate under the enhanced constraints imposed by the Building Societies Act (such as the ‘nature limits’ on the proportion of wholesale funding we are permitted to raise and the requirement that the majority of our assets are secured on residential property).
1 The overall charge for impairment losses in 2010/11 on loans and advances was down 35% on 2009/10 at just £359m. The average loan to value (LTV) of new residential lending remains very low at 66%, with the indexed LTV for the whole residential portfolio at 49%. Less than 1.4% of our new residential lending during 2010/11 was written at LTVs in excess of 90%. The proportion of Nationwide originated mortgage accounts three months or more in arrears is 0.68% and is less than a third of the CML industry average of 2.09% (March 2011).
46
4.3 At a time when considerable reforms are being made to the banking sector to improve stability and competition, a strong and competitive building society sector should also be a priority so that it is able to effectively challenge the ring-fenced banks on a more even playing field.
4.4 We would therefore urge that, hand in hand with the wider banking reform package, the Building Societies Act is modernised to remove its inherent anachronisms and inappropriate barriers to competition with the banks. This would allow societies greater flexibility and strengthen the competition that mutuals are able to provide (including in commercial markets).
4.5 The changes we seek are largely of a technical nature to give us greater flexibility in our risk management activities and would not alter the fundamental nature of what it is to be a building society (i.e. an institution focused primarily on retail deposit- taking and residential mortgage lending).2 But they would, in effect, recognise that in the financial services sector of the 21st Century, effective mutual challengers are needed to tackle the dominance of the big banks – both in the consumer and SME markets – leading to enhanced lending capacity and growth prospects across the economy. We would welcome the opportunity to discuss these changes further with Committee members.
5. We support the ICB’s proposal for depositor preference – but it should apply to all depositors, not just those with less than £85,000
5.1 The ICB has recommended that upon insolvency of a deposit-taker and in resolution, all depositors insured by the Financial Services Compensation Scheme (FSCS) should rank ahead of unsecured creditors. Currently, all bank depositors rank pari passu with unsecured creditors, whilst those in building societies are subordinate.
5.2 We fully support a move to depositor preference, ensuring retail depositors are nearer the head of the queue at insolvency. The potential burden on the rest of the industry through the FSCS will also be reduced.
5.3 However, we believe that the ICB should have recommended that all depositors, not just those insured by the FSCS, should receive preferential treatment on insolvency. This would create the best conditions for swift and easy resolution (e.g. transfer of customer business into a new bank which could trade on) and ensure that two retail depositor classes are not created (the insured and the uninsured), leading to an unnecessary complication.
5.4 If the Government is not minded to take this additional step, given the current position of building society depositors relative to those with banks, it should at least implement the relevant sections of the Butterfill Act (which provides for all
2 For example, they include permissions for building societies to be able to: Create floating charges which would enable us to settle repo transactions in treasury bills, gilts etc through ‘Delivery by Value’ (DBV), which is the market norm. This would afford societies cheaper funding costs allowing us to be more competitive in the market. Utilise derivative instruments for other legitimate business purposes, in addition to those risk management transactions that are currently permitted, subject to close supervision by the regulator. This would remove some of the commercial constraints on societies’ activities and lead to cost, and therefore pricing, benefits. 47
depositors to be ranked pari passu with unsecured creditors) simultaneously with the ICB proposals. This will ensure that both insured and uninsured depositors are in the same position (preferred to and pari passu with unsecured creditors respectively) whether they choose to deposit with a bank or a building society.
6. More competition in retail banking is welcome but costs of enhancing switching should not outweigh consumer benefits – simpler solutions should also be considered
6.1 Nationwide is highlighted by the ICB as the primary challenger brand to the big banks in retail financial services and we have consistently advocated greater competition. We fully support the aims of increasing current account switching and enhancing transparency of terms and conditions.
6.2 The ICB’s proposals to improve the switching process – a seven day guarantee and the creation of a redirection system for payments by September 2013 – will be costly (estimated to be between £650 million and £850 million) and the timescales challenging. However, we will be working closely with the rest of the industry to take forward this initiative.
6.3 To deliver swift results and improve consumers’ experience and perceptions of the switching process, the ICB could have focused more heavily on those companies acting as Direct Debit originators. Direct Debit originators do not always comply with the rules that state that amendments and cancellations must be actioned within three working days of receipt. We support Payments Council efforts to rectify the problem, and would advocate strong measures in this regard, possibly including extending the Direct Debit guarantee to include originators’ keying of amendments, publishing details of poor practice and fining or excluding poor practitioners from the scheme.
September 2011 48
Written evidence submitted by Consumer Focus
About Consumer Focus Consumer Focus is the statutory consumer champion for England, Wales, Scotland and (for postal consumers) Northern Ireland. We operate across the whole of the economy, persuading businesses, public services and policy-makers to put consumers at the heart of what they do. Consumer Focus tackles the issues that matter to consumers, and aims to give people a stronger voice. We don’t just draw attention to problems – we work with consumers and with a range of organisations to champion creative solutions that make a difference to consumers’ lives.
Introduction Our goal is the creation of a financial services marketplace where the companies that prosper are the ones that offer products which are good value, simple to understand and trustworthy. We wish to see consumers empowered to switch to the products that most suit them and take advantage of the best offers. There may never be a better time for Government to ensure that in the future the sector meets consumers’ and society’s needs. The Independent Commission on Banking (ICB) report provides a solid platform to ensure the sector is fit for purpose. We believe reforms for improving competition, ensuring real choice and universal provision of financial services are necessary to make the sector fit for purpose in the future. We support the measures to remove barriers to new entrants to a retail banking sector which has seen significant consolidation since 2007. However, a healthy financial services market should not just be a small number of major banks and big building societies. More innovation and diversity is needed including other models such as credit unions, community initiatives and post office banking. We have focussed our comments on the competition aspects of the ICB’s recommendation as this is where we have the most evidence and expertise.
Our response
Improving competition We agree with the ICB that strong interventions are needed in the regulation of banking products beyond the current OFT reforms, which have failed to deliver either consumer protection or an effective market place. In our response we assess ICB proposals to improve competition and consumer outcomes Switching process We are pleased the ICB has addressed the problems consumers face when switching. The current reforms put in place by the OFT following its 2008 report are not working. Reforms included improving the consumer experience in switching; most notably on ensuring Direct Debit transfers do not incur errors. Bankers' Automated 49
Clearing Services (BACS) also introduced an originator education strategy to ensure those firms who use Direct Debits have adequate systems in place to amend them. In addition, in December 2009, BACS promised that no consumer would lose out financially because of errors in the switching process from the bank or a Direct Debit originator. As consumers shift payments more and more to Direct Debit, it is vital reforms radically reduce the problems consumers face when switching in order for trust in the process to increase. Unhappily, and demonstrably, this is not the case.
Error rates in switching As the ICB notes, Consumer Focus undertook research with consumers and discovered a far higher rate of problems switching than had previously been found in the 2008 OFT report. Subsequent to the Interim report, new figures provided to the OFT by BACS showed error rates had actually increased from 7.6 per cent to 8.5 per cent. The ICB’s final paper noted that with an 8.5 per cent chance of a Direct Debit being sent to the old account, for an account with ‘multiple Direct Debits this equates to a substantial chance that at least one of them will go wrong’. It later adds: ‘there is a 46 per cent chance for a consumer with the average number of Direct Debits that at least one will go to the wrong bank’1 The ICB explains why the technical data showing a low error rate per individual Direct Debit does not transfer to an improved consumer experience when switching.2 It is three years since the OFT report into current accounts and still the error rate for Direct Debits remains stubbornly and consistently high. With consumers relying more and more on automated payment methods, it is right that the ICB’s proposed solutions involve automated transfers to ease of the switching process for consumers. We welcome the announcement by the Payments Council that the redirection service will be in place in 2013. It is important that the redirection service is designed to be in place for 13 months in order to capture every Direct Debit. This is because many customers have annual payments that will need to be successfully transferred. We must ensure that DDs captured by the automated process are updated by the firm or automatically through the process so problems do not resurface at the end of the automated transfer period. The Dutch example shows there is a danger that at the end of the automated period DDs will continue to go to the old account. If this can be implemented then the largest barrier that prevents those who wish to switch current accounts will be removed. We see less evidence for the ICB’s proposals on reducing the time taken to switch to seven working days from the current 18 working days. Our research did not identify consumer dissatisfaction with the time it currently takes to switch.3 We are as of yet unaware the extent to which the estimated costs are to create the infrastructure of the new service as against completing the switch in seven days. Further analysis and analysis of the costs–benefits of the constituent elements would be helpful.
1 ICB Final report, p219 2 ICB Final report, p185 3 Defined by BACS switching guide, and the EBIC code. This includes the when the new account must be operational (10 days) and when all automated payments must occur http://bit.ly/mBkiPt 50
Wider recommendations to improve the switching experience We believe two further alterations to the current switching process not mentioned by the ICB would encourage consumers to switch. a. Compensation In the long run the success of persuading more consumers to consider switching will depend on actual consumer experience. Trust in the process would be increased if consumers were confident that if things did go wrong they would be adequately compensated. That would mean that any fears, rational or otherwise, about errors rates would be tempered by the fact that their time and effort in resolving a problem would be adequately compensated. We recommended compensation (as well as restoration of any money lost as is already the status quo) to a consumer who has suffered an error, or if the agreed timelines and performance standards are not adhered to. That would encourage businesses to improve their performance and it would fairly compensate consumers who have had to chase up mistakes. b. Consumer information In 2009, the BACS working group established a guide for switching, a consumer website with tools and advice for switching, and template letters for consumers to use. We do not believe these initiatives are adequate. The promotion of switching could be better undertaken than under the current voluntary approach. The 'switching service', is only on the BACS website, which is largely aimed at industry not consumers, so unsurprisingly just 7,000 people looked at the site between September 2009 and September 2010.4 We found many banks’ websites do not refer to this website and nor is the documentation available in branches. The introduction of a new automated switching service offers a timely opportunity for radical improvements in the information provided to consumers to promote and navigate the switching process. We would like to take the opportunity of the automated processes to promote switching more widely than has been the case until now. The switching service information should be more actively promoted to consumers on banks' consumer- facing websites and prominently in branches. Tools to encourage and support switching, both to and away from banks, need to be accessible and crystal clear with easy-to-read scenarios that consumers can relate to their own circumstances. When the new service is launched the Payments Council should produce an information campaign similar to the ‘I love Chip and Pin’ campaign which went live on Valentine’s day 2006. Consumers will soon get an annual summary of charges and interest. That is intended to alert them to the cost of their account and potentially make them consider switching. We welcome that reform but its potential to encourage switching could be enhanced. We recommend the inclusion of a reminder on the annual summary that consumers have the right to switch. It could include a
4 OFT, PCA update, September 2010 51 reference to a website where consumers can compare offers such as on the Moneymadeclear website. This proposal has already been recommended and implemented by the Competition Commission following its investigation into the current account market in Northern Ireland.5 It seems appropriate for similar triggers to be available to consumers in Great Britain. This is also becoming best practice across other industries. For example, Ofgem has already introduced this in the energy sector following its Energy Supply Probe.
Consumers’ difficulties in understanding and comparing products As the Final Report makes clear, an improved switching process will only benefit around 12 per cent of Personal Current Account (PCA) customers. It states: ‘even with the switching reforms half of customers would be no more likely to switch accounts with the new system’6 thus, ‘this gives cause to be sceptical about claims that the impact of this measure on its own will be transformational for competition or consumer choice’. Thus, it is vital wider reforms are put in place to address complexity. In pure economic terms complexity is an additional cost to consumers, to assess and comprehend the market and to choose a suitable alternative provider. We do not believe the OFT reforms to date to improve transparency adequately resolve this problem. We believe creative thinking is needed to ensure consumers can more easily compare products on offer and identify which account suits them best. For all customers of current accounts (including Basic Bank Account users, customers who suffer unauthorised overdraft charges and those who stay in credit) achieving transparency and comparability is difficult at the moment because an assessment of value very much depends on your own personal circumstances, how much money you have and how you use it. Annual summaries are a welcome addition to enable consumers to see what they are charged. Yet, without consumers being able to easily understand the revised costs from an alternative provider the annual summary and switching service are unlikely to lead to a significant rise in the switching rate. With packaged accounts growing steadily this makes comparison even harder still since there are multiple products to compare. It also makes consumers even less willing to switch because to do so would impact on a range of financial products they currently possess. Thus, price complexity and bundling mean there are clear limits to the potential for reforms to enhance switching. ICB reforms – how to deliver transparency We agree with the ICB’s efforts to enhance ‘good’ competition and reduce firms’ ability to offer ‘bad’ competition. However, we are concerned that the transparency proposals lack bite and rely too much on recommendations for a future Financial Conduct Authority (FCA). The ICB report is right to identify significant changes to the operation of price comparison sites something we called for in Stick or Twist?. Currently, their use is limited because actual value depends on how each consumer uses their account.
5 Competition Commission, 2007, Personal current account banking services in Northern Ireland market investigation p184. Remedy f) http://bit.ly/c2wAoG 6 ICB, Final report, p220 52
Pricing remains too complex for consumers to know which account is best for them. Without price comparison tools that can assess value for the individual and their history, we do not believe there is any hope of price comparison sites playing a strong role in helping consumers choose. The only way to ensure price comparison tools are improved is with the addition of individual usage and account data in unison. It is noteworthy at this juncture to compare what is being done in other sectors. In energy, consumers can ‘plug in’ details of their bill into online price comparison sites to see which tariff is cheapest based on their usage patterns. There are differences that need to be worked through to ensure that industry specific problems are addressed. The largest one being that how consumers accumulate charges can vary enormously in banking, whereas in energy it is simply by usage. Potentially, a better comparison comes from the mobile phone sector. That industry also has complex pricing structures. As a result BillMonitor offer a service that allows consumers to see which tariff best fits their phone usage. Consumers simply have to consent to BillMonitor’s software reading the monthly electronic bill. The software then scans the market based on actual usage of differing services (minutes, peak and off-peak, texts, and mobile internet).7 Each month it generates a list of the best value tariffs for consumers based on actual usage. We believe further work could investigate the viability of such a comparison tool in the PCA market so consumers could base their assessment on which account offers best value based on actual evidence of how they have used their account in the past. There are clear problems that the ICB identifies in making price comparison sites a viable tool for comparison. We are happy to support all reforms proposed by the ICB on enhancing the service provided by price comparison sites. We share its recommendation that the My Data project should work through the difficulties that there will inevitably be in realising this agenda. We also share the ICB’s proposals to ensure banks hand over all required information on pricing in a useable form and include representative costs for differing consumer subsets. Yet, we caution the committee the reforms to switching and price comparison sites will only achieve marginal returns due to the nature of the PCA market. Free in- credit banking means consumers do not consider switching since to them the account is ‘free’ and where the alternative on the market, packaged bank accounts constitute complex bundling. These accounts are likely to further reduce consumers’ ability to compare, assess and switch. We discuss this further below.
Incorporate interest foregone in any annual summary We agree with this proposal as historically it has been an important factor in assessing the costs consumers face from banking. The arguments in favour of this proposal in paragraph 8.72 are reasonable and appropriate. To make this work will require additional information from the banks such as average daily balances. The ICB report suggests the future FCA should undertake consumer research on how to present that information. It adds that the additional information should be on bank statements from January 2013. As the Financial Services Bill has not even entered parliament, one wonders whether the FCA will be ready to take this
7 www.billmonitor.com 53 forward. The OFT is better placed to meet the end date as part of its work programme on the PCA market. Complexity and tariff numbers We agree the number of tariffs has grown too large. Preventing complexity is not simply about removing toxicity from products but is also about allowing consumers to understand and gain maximum value from the market place. Competition, as it currently operates in financial services, tends towards an increasing number of very similar products and this applies across all products in financial services. For example, the HM Treasury paper on Simple products has identified growing proliferation in the number of savings products. Consumers are unable to make informed choices about what best suits them and they believe the complexity is there to catch them out. All this means consumers are turned off from engaging in the marketplace. Thus, we support the ICB recommendation that the future FCA should work on standardisation. There are two distinct ways in which standardisation proposals can be moved forward:
1. Vanilla products: There are various work streams looking at a vanilla product type, and how to make that successful. HM Treasury are looking at how to deliver ‘simple products’ , the Financial Services Consumer Panel are developing proposals on ‘straight forward outcome products’ and the Association of British Insurers have developed some product minimum standards in the insurance industry. A recent Social Marketing Foundation paper on trust in financial services recommended the Government should also create a 'trusted product' kite-mark scheme to improve the quality of financial products, against which all other products must be compared.8
As the ICB recommends, the future FCA should take forward these proposals to develop workable and effective products that consumers can trust on current accounts with at most two or three useful and easily comparable variables.
We also firmly agree with the ICB that the new regulator should be able to challenge unarranged overdraft charges, not just on the transparency of the charges but also on the fairness.
2. The future FCA’s powers: In our response to the draft Financial Services Bill we called for an explicit recognition in the legislation for the future regulator to provide a distinct and lesser regulatory regime for products produced under a vanilla or standardised product model. We hope such an approach should reduce costs and uncertainty for firms looking to develop such products and ensure regulatory resources are focused less on products designed to be safe and secure than other complex products more likely to lead to consumer detriment.
Transparency on non-price information
We believe the best way to compare non-price aspects is greater comparability and transparency about complaint handling by firms as a proxy for customer service. Complaints data is the best guide available to assess firms’ commitment to treating
8 http://bit.ly/rjS6Mn 54 customers fairly, in terms of the amount of complaints, the uphold rate and and similar statistics from cases that reach the Ombudsman service.
Currently, the Ombudsman service and the FSA produce aggregated complaints data twice a year. Much more can be done to make this data useful, from more nuanced complaint categories, to complaints in relation to market share and finally by better presentation of the data through clear graphics. Consumer Focus already aids consumer comprehension by producing comparative tables on the largest banking brands that produce the vast majority of complaints.
This data can be further enhanced, helped with changes to the publication of data, and more widely disseminated. We believe the Money Advice Service, through its Moneymadeclear website, should lead on this work. Each of the banks should have to carry comparative tables on its website, provide such information to consumers thinking of switching and also in brochures as part of switching information in store.
Impact of free in-credit banking model on reforms Although we welcome the ICB’s proposals to improve transparency and enhance the switching process there is a limit to the impact this will have on the market for current accounts. We believe this is largely to do with the free in-credit pricing model. When consumers are charged based on future unpredictable usage, evidence from the OFT shows consumers do not assess the charges in a rational way needed to ascertain and choose based on a rational appraisal of value. 9 Furthermore, as the charges are both behaviourally dependent and deeply complex, it is difficult even if you know your past annual charges to know which account will be appropriate for you in the future. Evidence shows product complexity leads to a lack of trust in financial products. 10 Our report on switching found three quarters of consumers had never even thought about switching their bank accounts in the last two years.11 The ICB is right to note the problems of ‘demand side weaknesses’ are even more pronounced in the PCA market than in any other financial services industry. We believe improvements in transparency and comparability, and ultimately switching, can only occur with radical prescription over the pricing mechanisms available to banks to ensure unfair and manipulative pricing strategies do not undermine efforts to improve competition. Without changes to pricing to make costs transparent the effective discipline of market forces cannot apply, leading to detrimental outcomes for consumers, market inefficiencies and productive losses. Thus, while we welcome the recommendations on transparency they must surely comprise elements in a wider strategy to ensure charges and revenue in the PCA market are clear, upfront, comparable and transparent. Without a clear iteration of the need for clear and transparent charges there is a danger that banks may migrate charges onto ever more novel ancillary aspects of products, furthering complexity and opacity but in new ways. While a logical solution would be to charge consumers up-front fees for the bank accounts – either via a transaction charge or flat rate – no bank dares to be the first
9 OFT, Price Framing, 2010, OFT Personal Current Account: A Market Study 2008, and follow up report 2009. 10 HM Treasury provides ample evidence of this in their recent paper on simple products 11 Consumer Focus, Stick or twist, p31 55 to charge as they risk losing market share to rivals who decide to hold out longer. The free in-credit model of banking seems unsustainable and Consumer Focus is not in principle opposed to charging for bank accounts. However any move from the free in-credit model should be accompanied by a clampdown on unfair ancillary charges and a move to more transparent charging. Clear up-front charging would allow for much easier comparison and may promote a competitive market in current accounts. However there will be many losers not least among those consumers on low incomes who are able to stay in credit. Effects on low income consumers It is clear moving forward banks are likely to offer lower income consumers continually descending levels of service as banks seek to limit costs. For example RBS and Lloyds have restricted the access their basic bank account holders have to their money via the Link system. There are two reasons for this: greater inelasticity of demand from low income consumers; and firms offering attractive deals to richer consumers as part of a ‘cross selling’ strategy. The dynamic of market competition (supplier profit incentives and consumer choice) simply does not apply to ensure banking products meet lower income consumers’ needs. Consumer Focus evidence on current accounts and cash ISAs shows it is the minority – those in higher social categories – who switch more and are more likely to switch when these deals come to an end.12 Stick or twist found the social grades D or E have switched less and thought about switching current accounts less than other consumers. Efforts to increase switching therefore are likely to disproportionately benefit higher income social groups who may be more likely to engage in a more transparent market. Lower-income groups are less engaged and are likely to remain so. Secondly, firms are less concerned about providing products that meet low income consumers needs as they are less profitable. Many commentators have noted the PCA is increasingly seen as a gateway product for the banks through which they can promote other products such as savings, investment and mortgage products.13 Consequently, many banks are offering attractive teaser deals but for those with high monthly balances. Consequently, market reforms offered by the Vickers report, although welcome, are insufficient for low-income consumers as they may simply encourage an even greater cross subsidy from those customers not interested in switching to those who are tempted with introductory offers.14 More needs to be done to help those lower income consumers neglected by banks, who do not see them as profitable enough to provide with appropriate products. Bank accounts are essential services and policy-makers need to think about those at the bottom for whom enhanced market competition will do little to reach. s September 2011
12 Research in switching in Stick or Twist, October 2010, research in Cash ISAs, February 2011. 13 For example Mintel, Retail Banking overview, November 2010 14 A recent report from the SMF made this point clearly. http://bit.ly/rjS6Mn
56
Written evidence submitted by the British Bankers’ Association
Introduction
1. The British Bankers’ Association welcomes the opportunity to provide written evidence to the Treasury Committee in respect of the final report of the Independent Commission on Banking. We represent 220 banks from 60 countries on UK and international banking issues.
2. This submission outlines our views on:
⋅ The interrelationship between the ICB’s recommendations for the UK and the international reform programme and the need for a comparative analysis setting out incremental costs and benefits of the additional measures.
⋅ The retail ring-fence and its effect in practice on banks of different types and sizes and their ability to meet customer needs.
⋅ The combination of the loss-absorbency proposals and depositor preference and whether the proposals overall may combine to have a disproportionately negative effect on long term bank funding.
⋅ The need to understand the potential consequences of the proposed introduction of a leverage ratio that may be more constraining than the equivalent measure in Basel III.
⋅ The ICB’s assessment that its recommendations would not unduly impact international competitiveness, including its requirement for additional loss absorbing debt to apply to the broader group operations of UK headquartered banks.
⋅ The extended timetable proposed for the introduction of resulting measures.
3. A further consideration is that the report does not necessarily weigh up all of the consequences of its proposals. It is possible, for instance, that incremental measures aimed at reducing the impact of failure may have consequences that may be of broader detrimental effect. An example would be the proposed introduction of depositor preference. While this reinforces the need for shareholders and creditors to bear losses in the first instance, if it has an undue bearing on the price and availability of unsecured medium to long term funding then the economic effect may outweigh the benefit.
4. As the ICB’s recommendations have potentially far reaching consequences for individual banks and, the sector generally and for the wider economy, we see a need for HM Treasury to ensure that there is appropriate consultation with a wide range of stakeholders in determining the approach to implementation and a full and thorough cost/benefit analysis of the potential impacts. We stand ready to contribute to these processes.
57
5. We should add that the ICB report was published less than three weeks before the preparation of this written evidence and that we are still in the process of analysing key aspects in consultation with members. We are pleased to share our initial assessment with the Treasury Committee, but would underline the tentative nature of the views that we are so far able to express.
Aims of reform
6. The ICB report explains that the international reform agenda – notably the Basel process and European Union initiatives – is making important headway but adds that the ICB considers that this needs to be supported and enhanced by national measures, which the ICB sees as especially important given the position of the UK as an open economy with very large banks extensively engaged in global wholesale and investment banking alongside UK retail banking. It sees part of the challenge for reform to reconcile the UK’s position as an international financial centre with stable banking in the UK.
7. The ICB sees further reform measures as necessary in order to ensure not only greater resilience against future financial crises and removing the risk from banks to the public finances, but also to achieve a banking system that is effective and efficient at providing the basic banking services of safeguarding retail deposits, operating secure payment systems, efficiently channelling savings to productive investments, and managing financial risk.
8. Whether in terms of the proposal for a retail ring-fence or the specific proposals for increased loss-absorbency, however, the report stops short of providing a comparative analysis setting out the benefits and disadvantages of the UK adopting measures that differ considerably from the internationally agreed path built up on the basis of consensus within the G20 and the bodies reporting to it including the Financial Stability Board. This is a shortcoming that will need addressing at a future stage.
The retail ring-fence
9. The ICB recommends the introduction of a ‘ring-fence’ between retail banking and investment banking. The retail-ring fence will be required to be a separate legal entity and to meet regulatory requirements for capital, liquidity, funding and large exposures on a standalone basis, with dedicated operational and support services, an arm’s length relationship with the wider group, and an independent board. The ICB allows for some flexibility for banks to choose how much of their corporate banking business they put inside the ring-fence, but not for banks to allow funding to pass through it. The ICB envisages ring-fenced banks being able to provide ‘one stop’ services to their customers through agency agreements between the ring- fenced bank and other parts of the group.
10. The ICB views the retail ring-fence as:
58
⋅ Providing a more proportionate response to the crisis than a total separation of retail and wholesale/investment banking and a means by which many of the benefits of diversification within a universal bank can be maintained. ⋅ Offering additional protection to core retail services including greater assurance of being able to implement a resolution plan in the event of financial difficulty being encountered. ⋅ Enable banking groups still to service fully the needs of corporate and other clients through the use of ‘agency agreements’ between the retail ring-fenced bank and other parts of the banking group.
11. The retail ring-fence is a vastly different proposition from the recovery and resolution plan initiative currently underway. It puts in place a firewall that reduces the prospect of the retail entity being exposed to untenable losses in the wider group but comes at a cost of increased organisational complexity and some loss of the benefits of diversification. It aims to make banks easier and cheaper to resolve, with vital services maintained, and is in addition to measures intended to strengthen the resilience of the financial system, whether in terms of increased capital and liquidity standards under Basel III, infrastructure changes, closer banking supervision or the planned introduction of a macro-prudential element to regulation under the direction of the new Financial Policy Committee. These are in themselves all highly significant initiatives and will contribute to financial stability to a very substantial degree.
12. A consideration on the cost-side should be that the UK adopting the ring-fence approach will provide a lead to other jurisdictions favouring the application of legal and regulatory requirements on a local basis leading to the trapped pools of capital and liquidity, which in good times must reduce lending capacity and in bad times could arguably reduce the ability of banking groups to respond to financial difficulty. At the very least, it would appear possible that third country supervisors may be inclined to apply ring-fencing measures locally to the operations of UK ring- fenced banks since their interests will be overridden in favour of the UK ring-fenced bank.
13. Other concerns relate to the operability of the retail ring-fence and whether the ICB is right in its belief that a ring-fenced bank will still be able to make available a full range of financial services to customers. This will be dependent upon the way in which a banking group will be able to organise its business in light of the division between mandated, permitted and prohibited activities described in the first three ‘principles’ upon which the retail ring-fence is to stand and needs careful consideration. Further thought also needs to be given to whether there are unforeseen consequences from the fourth and fifth principles respectively setting out the legal and operational expectations upon the retail ring-fence and the expectation that any economic linkage between the ring-fenced bank and the wider corporate group be entirely on a third party basis. This, together with large exposure limitations, may work to unduly constrain the extent to which the ‘agency agreements’ envisaged by the ICB can ensure the provision of a ‘one stop’ service.
14. A further issue may be the appropriateness or otherwise of limiting the ring-fence to services integral to the provision of payments services to customers in the European 59
Economic Areas (EEA) or to intermediation between savers and borrowers within the EEA non-financial sector. Accepting the intention to protect the ring-fence from direct exposure to global financial markets and activity that would significantly complicate its resolution, we would nevertheless question whether the EEA is necessarily the right place to draw the line. The report, as drafted, explicitly allows lending to a UK subsidiary of a non-EEA group, with paragraph 3.44 stating that a ring-fenced bank “could serve companies incorporated within the EEA, or with substantial business in the EEA, provided that the transaction also took place within the EEA and was subject to the law of an EEA member state.” The report equally gives a helpful illustration of what it explicitly views as not permitted, using the example of providing mortgages to American homeowners or a loan to an Australian energy company with no base, or subsidiary, in the EEA. While this would appear to provide a reasonable dividing line care will be needed to ensure the division works as intended in practice
15. We are also aware of concern amongst smaller banks that flexibility intended to deliver a proportionate approach may require clarification or refinement in order to ensure that they are not unduly impeded from organising their businesses to meet the specialist needs of their customer bases in a reasonable way under the new arrangements. The ICB appears to have made assumptions (for instance in paragraph 3.15) about these providing services mainly inside (or outside) the ring- fence and this may not be the case. The recommendation as currently drawn up may therefore involve disproportionate reorganisation and reporting costs for small banks. The report also suggests, at paragraph 3.85, that “a ring-fenced bank should make, on a solo basis, all disclosures which are required by the regulator of the wider corporate group and/or its other relevant substantial subsidiaries, and those which would be required if the ring-fenced bank were independently listed on the London Stock Exchange”. Our understanding is that one interpretation being given to this is that a ring-fenced bank would need to make full listing disclosures irrespective of whether the parent company was listed. It is difficult to see how this could be viewed as proportionate.
16. Paragraph 3.86 explains that a ring-fenced bank could not be the parent of (or have any equity holdings in) any entity except other ring-fenced banks. While we appreciate that the intention is to place appropriate constraints on the activities that can be undertaken from within the ring-fence we believe that some members may wish to make a case for certain interests to be permitted providing they are not inconsistent with the principles determining the demarcation of the ring-fence.
17. The geographical scope of ring-fenced banks is determined by the requirement that they could only provide services within the EEA. This would mean that they could provide services to individuals within the EEA, whether permanent resident or visitors – an important provision – and as mentioned above serve companies incorporated within the EEA or with substantial business in the EEA, but not serve non-EEA customers from within the retail ring-fence. While the emphasis on the retail ring-fence only providing services to customers within the EEA, or with substantial business in the EEA, on the basis of transactions taking place within the EEA and subject to the law of an EEA member state, this will need working through to ensure it works in practice.
60
18. Paragraph 3.17 explains that there are a small number of individuals who are better equipped to plan for an interruption to their banking services and therefore do not meet one of the core criteria for what should be viewed as a ‘mandated service’ that can only be provided from within a retail ring-fence. The ICB notes that this may apply in particular to very high net worth private banking customers, for whom exemption could apply if they certify that they understand that their deposit is being placed outside the ring-fenced bank, but cautions that the authorities should place stringent limits on the use of such an exemption to “guard against attempts to use this exemption to conduct general retail banking outside the ring-fenced bank”. While we broadly concur with the objective, the precise dividing line may give rise to issues of a practical nature which need further consideration.
19. A further practical consideration is whether the introduction of the retail ring-fence would impact upon the ability of banking groups to meet future requirements for a Net Stable Funding Ratio (NSFR). The NSFR requires banks to match more of their long term assets with long term funding, cutting across the fundamental role that banks play in society of maturity transformation. It is not clear that investors will have sufficient appetite to provide the long term funding that the NSFR demands given that they will rank behind retail depositors because of depositor preference. If they are prepared to do so it will likely be at an elevated price, impacting the provision of funding by banks to their ring-fenced borrowers.
Loss absorbency
20. The ICB recommends that:
⋅ Large ring-fenced banks holding more than the equivalent of three per cent of UK GDP in risk-weighted assets (RWAs) be required to hold at least ten per cent equity capital and for similar arrangements to apply for medium-sized banks (defines as those with a ratio of RWAs to UK GDP of 1%-3%) on a sliding scale.
⋅ All UK headquartered banks and all ring-fenced banks respect the Basel III leverage ratio of three per cent (i.e. putting in place a backstop based on lending being no more than thirty-three times total assets) and requires this to rise to a little over four per cent (or a lending ratio of a little under 25 times) for the larger ring-fenced banks.
⋅ Resolution authorities should be given primary powers over a new class of bail-in bonds and secondary powers to impose losses on other unsecured liabilities; FSCS insured depositors be given creditor preference in insolvency and resolution.
⋅ UK-headquartered global systemically important banks (G-SIBs) and the larger ring-fenced banks as defined above be required to hold capital and bail-in debt equivalent to 17 per cent; and that the supervisor of UK-headquartered G-SIBS and medium-sized ring-fenced banks as defined above be entitled to require the bank to hold an additional loss-absorbing capacity of up to 3 per cent if they have concerns about the resolvability of the bank.
61
21. Paragraph 4.47 envisages that if a bank is subject to both a ring-fence buffer and a G-SIB surcharge then it is only the higher of the two which should apply. It is unclear however whether it is also the intention that the ring-fence buffer should provide additional loss absorbing capacity pre-resolution. Under the FSB proposals for the G-SIB surcharge the additional capacity can be called upon but involves agreement on a capital remediation plan to return to compliance over a timeframe to be established by the banking supervisor. Until such time as the plan has been completed and compliance achieved, the G-SIB is subject to the limitations on dividend payout defined by the capital conservation buffer bands and to other arrangements as required by the supervisor. We would underline the importance of the ring-fence buffer working in a similar way.
22. The leverage ratio recommended by the ICB of 4.06% is significantly more constraining than the Basel III 3% ratio. Paragraph 4.57 explains that this results from uplifting the Basel III baseline for the ratio of Tier 1 capital to RWAs from 8.5% to 11.5% to reflect the ICB’s recommendation that the 7% Basel III baseline be increased to 10% for large ring-fenced banks. Box 5.1, on page 149, on the other hand reminds us that the draft Regulation for CRD IV does not as yet contain any firm proposal for introducing a leverage ratio, but instead suggests that firm data and experience be gathered before an effective leverage ratio is introduced as a binding requirement in each jurisdiction. The ICB recommendation therefore gives rise to a need to understand the potential consequence for introducing a ratio that may be more constraining than the equivalent Basel provision. One concern, for instance, is that ratios of this nature discriminate against entities that have larger portfolios of lower risk assets. The business implications of the recommendation must be understood and it is unclear to us whether the ICB had a proper opportunity to look at this other than in terms of what may be the mathematical consequence of a related change.
23. The ICB makes clear that its proposals for a retail ring-fence and increased loss- absorbency should be viewed as a ‘package’ and that without structural change they would be recommending even higher capital requirements. A mirror image of this would be to ask whether the proposals together – the ring-fence which reduces the integration of the universal bank offering, the bail-in proposals and the proposed introduction of depositor preference and other changes in the creditor rankings - combine to make investment in UK ring-fenced banks and non-ring- fenced G-SIBs an unattractive proposition for senior debt holders. We need therefore to work through the different component parts of the package to ensure that each adds more than it removes from the equation.
24. The minutes of the latest meeting of the Monetary Policy Committee explain that one consequence of the recent turbulence has been the virtual closure of corporate bond and bank term funding markets to new issuance and that a consequence of UK banks being unable to access unsecured term funding markets may be a pressure to reduce lending1. This illustrates the importance of understanding the effect of the proposals on funding markets. Furthermore, it should be recognised that whilst banks have been successful in attracting term funding from wholesale markets it remains to be seen how the appetite for UK bank debt will evolve under a
1 Paragraph 5, Minutes of the 7th&8th September MPC meeting 62
regime which includes explicit bail-in conditions (which may look different to those in other jurisdictions) and against the backdrop of regulatory changes which may alter the appetite and ability of some classes of traditional investors to hold bank debt, not least due to Solvency II, which attaches higher capital charges to medium and longer term funding instruments on the part of insurers.
25. Our initial assessment is that need for depositor preference may add very little to the loss-absorbency recommendations given the increased capital levels and the European initiative expected to result in a measure of pre-funding for deposit protection schemes. While there is a logic to depositor preference, and unsecured debt holders subsuming losses before protected deposits in the event of insolvency (and all deposits in a resolution through the bail-in mechanism), there is a risk that shifting this exposure from the industry generally through the deposit insurance arrangements to unsecured debt holders may result in an undue loss in investor demand for these instruments. These considerations were explored at some length in the recent consultation by the Financial Stability Board on effective resolution. This is an aspect of the ICB’s proposals that we consider needs much closer analysis before decisions are taken on how to proceed.
26. Irrespective of the differences in perspective over whether capital and liquidity standards are better viewed as maximum or minimum in nature, we would see less difference of view over the benefit of the UK ensuring that its approach to bail-in debt fits within the European statutory regime currently under development. Good progress is being made on this, with a draft EU Directive due for publication next month, and we see strong grounds for the UK ensuring that its approach achieves full consistency with the European regime. This would clearly strengthen the prospect of orderly recovery or resolution, enhance cross-border cooperation and in any case is likely to be an EU statutory requirement.
International competitiveness
27. The specific ring-fence buffer is to apply only to the ring-fenced bank on a solo basis (paragraph 4.45); whereas for UK G-SIBs the requirement for primary loss absorbing capacity of at least 17% of RWAs is to apply to both the group as a whole and to individual UK-domiciled banks within the group (paragraph 4.121). This means that within a UK universal banking group any ring-fenced bank and any (UK) non-ring- fenced-bank would need to meet any requirement to have primary loss absorbing capacity separately. This requires the group as a whole to hold substantially higher loss absorbing debt than envisaged under Basel III. It is difficult to reconcile this to the ICB’s prime objective of protecting core retail banking services. In paragraph 4.40 the ICB explains that in “in order to allow the wholesale/investment banking operations of a UK bank to compete in global markets, they should not be required by regulation to have more equity than that agreed at international level”. It adds, however, that they should have credible resolution plans including the ICB’s requirement for additional loss-absorbing debt. The implication therefore is that the ICB believes that the wholesale/investment banking operations of UK banks can bear the additional loss-absorbing debt requirements without any undue effect on their international competitiveness. This would clearly merit close appraisal.
63
28. The ICB report (in paragraph A3.104) explains that ring-fenced banks may seek to offset part of the increase in costs associated with the restructuring by charging higher prices to borrowers. It dismisses this however since: a) where there are already alternatives to loans and other services provided by UK banks, such as financing from the capital markets or from non-UK banks, the ability of banks to pass higher costs through would be limited: and b) that while UK banks may react by raising lending spreads, the effect on the total supply of credit to customers would be limited as they switch into substitutes. The report (in paragraph 5.82) concludes that the competitiveness of wholesale/investment banking should not be unduly reduced since the UK banks represent only 15% of the international financial services sector as a whole.
29. We would view these statements as being indicative of the ICB being dismissive of the potential competitive effect on the prospective retail ring-fence banking groups and the potential consequences for their customers, whether retail or corporate. The analysis assumes the continued availability of non-UK bank finance and implies that if the price of services from a ring-fenced bank increases significantly then this will not be of significant effect. This appears to be on the premise that the ring-fence will only impact upon domestic retail business and – should the cost of lending from UK retail ring-fenced banks rise – customers can always borrow from non-banks or from (non-ring-fenced) foreign banks. In addition to highlighting the limited scope of the ICB’s recommended approach, this makes the assumption that non-UK bank sources of finance will be available, which as the experience of the financial crisis has shown may not be the case.
Cost-benefit analysis
30. Given the importance placed on impact analysis by the Basel Committee and other regulatory bodies in determining their requirements it must be imperative that the ICB recommendations be subjected to as rigorous a process. The report makes some attempt at quantification of the effect of removing the implicit government guarantee or indirect ‘social cost’ and places the direct ‘private cost’ of the ICB’s recommendations at £4bn to £7bn per year to be borne by a combination of bank shareholders, employees, creditors and/or borrowers. Paragraphs 5.59-5.63 explain that this estimate was put together by the ICB on the basis of estimates of costs put into the public domain by a number of analysts suggesting annual costs of between £2bn and £10bn – with an average of £6bn – and information received by the ICB on a confidential basis.
31. As paragraph 5.59 observes, none of the analyst estimates cost precisely the package of recommendations contained in this report – a notable exception being that they cannot have built in the cost associated with the non-equity loss absorbing capacity recommendations since their scale and nature, and depositor preference, cannot have been predicted. It is therefore clear that in taking forward the proposals the Treasury will need to undertake a more thorough analysis based on the recommendations themselves as opposed to an approximation based on what it was that they were envisaged to be.
Implementation timetable 64
32. While the 2019 timeline for the retail ring-fence has been questioned by some, it needs to be appreciated that the organisational, legal and administrative tasks involved in bringing about the ring-fence will be substantial and that implementation will necessarily be preceded by legislation and detailed regulation. We would therefore say that a realistic approach would be to put in place the statutory and regulatory framework in as feasible a time as possible and then to give an extended implementation period. The ICB recognises that introducing the retail ring-fence is likely to involve substantial legal and administrative challenges, including the obtaining of third party consent to the transfer of contracts and the separating out of contracts between the ring-fence and other group entities – but does not view these as insurmountable.
33. The ICB has proposed an extended implementation timeline of 2019 for its loss- absorbency proposals, which coincides with the timetable for the introduction of the higher capital standards agreed under Basel III. While some have described this as too long a period, others have questioned whether it is long enough, recognising that banks need time to build up their capital if further demands upon them are to be met by means other than restricting lending. The additional loss-absorbency proposals may also have a significant effect on the supply and cost of bank funding. The recommendations have serious potential consequences and must require further detailed consideration. It also needs to be borne in mind that the UK is one of the jurisdictions that have committed to introducing a counter-cyclical capital buffer of up to and possibly above 2.5%.
Competition
34. The ICB also made a number of recommendations on competition. First, it wishes to see the LBG divestiture result in the emergence of a 'challenger' brand. Second, it wishes to see progress made on account switching and transparency. And third it proposes that the new Financial Conduct Authority be given a statutory objective for competition. It has further recommended that if sufficient progress has not been made on these recommendations by 2015 then the Office of Fair Trading should think about making a market referral to the competition authorities.
35. In most respects, these recommendations are in line with developments in train and so the report can be seen as the ICB setting out with clarity what it wishes to see achieved - and by when. The industry, for example, is working on an initiative for improving accounts switching and the ICB has set a demanding - but by no means unachievable – standard and timetable. On the recommendation that the FCA be given a statutory objective for competition, our main concern would be to ensure that there is clarity in terms of the expectations that this places on the FCA and the way in which this lines up with primary responsibility for competition resting with the competition authorities.
Closing remarks
36. We would reiterate that we are only at the early stages of our consideration of the ICB report and that we plan to give the issues outlined above further thought over 65
the forthcoming weeks and months. While it is our intention to work with the grain of what the ICB has proposed we cannot rule out the identification of aspects of the proposals that would merit significant reconsideration.
37. We would also underline the effect that the proposals will have on the ability of banks to lend into the broader economy and the imperative therefore of any Government proposals building on the ICB’s recommendations to be accompanied by a robust cost/benefit analysis, with consideration given to the need for an extended implementation period if we are not to unduly impede the lending activities of UK ring-fenced banks.
38. We are also not convinced that the ICB gave sufficient consideration of the competitive effect on UK institutions and their diversity and whether this could be to the detriment of their client-base, whether retail or corporate, and therefore the good of the economy.
30 September 2011
M:\Business Papers\INQUIRIES\ICB Final Report\Written Evidence\For Publication\ICBF12 - BBA.docx 3 October 2011
66
Written evidence submitted by the Association of Corporate Treasurers
Executive Summary
1. The ACT is pleased to see that the ICB has tried to be practical and well balanced in its proposals in the Final Report. We accept that there are benefits for the UK in attempting to avoid, or reduce the risk or impact from, financial crises even when set against the ongoing costs of structural reform that have to be borne.
2. The ICB has set out principles, but precise wording of consequent primary and secondary legislation and subsequent rule-making must be seen before full implications for banks and for their business customers, with their individual contingencies, can be fully evaluated.
3. The requirements for increased capital for banks may however reveal a serious problem over shortage in the supply of equity and need for non financial companies themselves to raise more equity. An extended implementation period could help here.
4. The capital proposals from the ICB, taken together with re-regulation measures in progress driven by the G20 agenda risk reducing the availability of bank funding for business. We are sympathetic to the views of US regulators that the effect on the real economy of the G20 motivated changes cannot be accurately estimated1. Large companies can have access alternative markets not available to smaller companies. It is important that any structural changes to the UK banking system be accompanied by significant and practical measures to encourage the flow of finance to both SMEs (small and medium enterprises) and mid-sized companies.
5. The proposed design of the ring fence generally can achieve the separation required but retain sufficient flexibility to prevent undue distortions and inefficiencies in the market. The flexibility is to be welcomed.
6. There are, however, some very significant changes proposed, not least in operational terms for the banks affected. It is important to resolve the reforms to be introduced with due speed (allowing time for detailed consultation) so as to remove the destabilising effects of uncertainty. An extended period for
1 i) The Financial Times of June 8th 2011 reports that Jamie Dimon of JPMorgan Chase asked Ben Bernanke if anyone had “bothered to study the cumulative effect of all these things?” To his great credit Bernanke replied with some candour: “I can’t pretend that anybody really has... We don’t really have the quantitative tools to do that.” ii) John Walsh, Acting Comptroller of the Currency commented to a dinner in London, June 21, 2011: “I want to urge due caution regarding the cumulative effects of all the contemplated changes.” .... “In considering whether we’re getting all this right, I am reminded of the saying: “In theory, there is no difference between theory and practice. In practice, there is.” We don’t know how all of these new approaches will work in practice, how they may interact with one another, and what their cumulative impact will be.” (http://www.occ.treas.gov/news‐issuances/speeches/2011/pub‐speech‐2011‐78.pdf)
67
implementation is desirable so that all parties, banks and business customers, can adapt. This task should not be underestimated.
The Association of Corporate Treasurers (ACT)
7. The ACT is a professional body for those working in corporate treasury, risk and corporate finance, providing the widest scope of benchmark treasury qualifications. Our 4,200 members and 2,400 students work widely in companies of all sizes through industry, commerce and professional service firms. Our members working in non financial services companies are typically responsible for their company’s dealings with the banks and financial markets.
General
8. The ACT regards the ICB Final Report as pragmatic and, seemingly, balanced. Whilst the changes and challenges for the affected banks are hugely significant we believe that the implications for customers, large and small, and their day to day banking needs, will not be so material. Nonetheless it will be beneficial to resolve any uncertainty quickly by taking clear decisions and progressing the legislation as soon as possible and then allowing for a much longer period for an orderly implementation.
9. At present there are many new elements of financial regulation in train, driven often by the international agenda. The ICB recommendations propose relatively small changes in the context of these other regulatory changes for banks and markets following the financial crisis. Taken together the regulatory changes in prospect are very significant and inevitably complex.
10. We are at an early stage in considering all the implications of the Vickers report and of the international G20 inspired re-regulation generally. It may be that as the details are resolved for particular elements, further particular difficulties and unexpected interactions will become apparent. It will be necessary for legislators and regulators to be prepared to make appropriate amendments and adjustments.
Capital
11. The ICB recommends a requirement for up to10% equity capital for large ring- fenced banks which is very similar to the 9.5% level required under Basel III / CRD IV for systemically important banks. There is then a requirement to bring the loss absorbing capital up to a cumulative amount between 17% and 20% of risk weighted assets. Without wishing to specify a precise level we recognise that an additional buffer is required to diminish the likelihood of bank failure if subject to significant shocks. Reducing the occurrence of financial crises carries with it a significant benefit to business and the economy. Theoretically there should be a price and rate of return which is sufficient to generate a demand for
68
this sort of bail-in bond or similar capital, but we remain doubtful about the market’s capacity and willingness to provide this capital in sufficient volumes.
12. A quantitative impact study by the Basel Committee on Banking Supervision shows banks worldwide would need additional capital of €175bn to reach a core capital ratio of 4.5% proposed under Basel III and €600bn for the 7% requirement (euro area bank equity issuance has been $20 to 50b annually since 2005).
13. If there is indeed a shortage of capital, the banks can instead achieve their target ratios by shedding assets, in other words by reducing the extent of their lending.
14. Our members working in business are normally responsible for the funding of their companies. If the banks are in the event unwilling or unable to lend, affected companies will have to adjust their own capital structure and will come to depend more on equity or capital markets.
15. Although corporate gearing in the UK has fallen back somewhat in the past year, it is still very high historically. Anecdotally, our members are indicating that they are beginning to plan to reduce gearing – partly to move to a more robust structure able to withstand uncertainty and partly for fear of lack of bank funding or availability of capital markets in the years ahead. We have concerns over the capacity of the markets to provide this new capital for companies and over the cost particularly at a time when the banks themselves will be raising capital and governments probably being more highly indebted themselves.
16. Share capital cannot be raised easily at the exact point of need, but rather it has to be raised when markets are receptive, in advance of need. This timing effect will tend to reduce corporate leverage and increase the requirement for equity even more. This prefunding and generally cautious approach will result in companies operating at gearing levels that may be sub-optimal from the point of view of stakeholders, including shareholders, and society at large. This puts pressure on weighted cost of capital deployed and thus, at the margin, on business activity across the economy.
17. We do hear arguments that if the banks have to hold additional layers of loss absorbing capital this will come at a cost and that with reduced gearing their returns on equity can only be preserved if their lending rates rise significantly. Treasurers accept that pre 2008 the amounts charged for credit and risk were underpriced and that it may be “correct”, in some sense, for prices to have risen. But clearly treasurers and their companies have a very strong interest in keeping the cost of credit down – it ultimately drives the viability of what they can invest in and thus jobs and economic activity generally.
18. We agree that it would be appropriate for less risky banks with more conservative capital structures to deliver a much reduced return on equity. We
69
have seen the Bank of England paper from David Miles and others2 and find persuasive their arguments that with much increased capital the cost of bank funding for their customers might only rise by a modest amount.
19. However, we also think that there might be an expectation that annual bank returns on capital in the mid or high teens seen in recent years might fall in future years generally rather than being restored to more normal levels by the periodic effects of financial crises. As regards large corporate banking, the ICB’s Interim Report noted “It is clear that there is a lack of price transparency in this market and that for some products and services prices are very high. The remuneration levels of employees involved in providing some of these services do not give confidence that competition is working well for customers.”3 So there may be some cushion available there.
20. The ICB report proposes that the 17% cumulative loss absorbency capacity is required in both the retail bank and the non ring-fenced banks. Given that the ring-fenced bank is supposed to be capable of surviving an insolvency of the non ring-fenced side and is recommended to be capitalised accordingly, presumably this is to protect the external banking system as a whole – the same purpose as the Basel III proposals. We are not best placed to judge if the Commission has justified querying the appropriateness of the Basel III proposals for capital on the non ring-fenced side. If not justified, such a change would weaken the international competitive position of those UK universal banks with retail operations to which the ICB recommendations would apply.
Ring Fence
21. We think that the Commission has done a good job in its recommendations for how a ring fence between retail and wholesale banking should be positioned and function, given that UK resolution proposals for distressed banks already require separability - distinct from separation - into different businesses.
22. The ACT is pleased to see the Commission recommends that large corporate loans and deposits are permitted on both sides of the ring fence. It is also encouraging to see that modified ‘one-stop’ relationships for customers who want both retail and investment banking services would be possible, as would expertise, information and sharing of operational infrastructure across subsidiaries. These were some of the ACT’s key concerns when it engaged with
2 Optimal bank capital by David Miles, Jing Yang and Gilberto Marcheggiano http://www.bankofengland.co.uk/publications/externalmpcpapers/extmpcpaper0031.pdf. 3 Interim Report of the ICB at 2.82. [The ACT noted the high targets for returns on corporate relationships of banks in the Appendix to its response to the HM Treasury discussion paper on non‐bank lending in early 2010. http://www.treasurers.org/hmt/nbl/actresponse, at page 15ff.]
70
the Commission at the consultation stage and they play an important part in the efficient day-to-day functioning of businesses large and small.
23. Allowing wholesale deposits with the ring-fenced bank provides a welcome flexibility for company treasurers. However the preferred status given to the FSCS insured deposits subordinates those deposits and means that once there are any signs of distress at a ring-fenced bank those deposits, kept short-term in anticipation, will probably be promptly withdrawn en masse, destabilising that bank and causing a lack of liquidity and perhaps triggering failure. Alternatively we expect creditors will seek collateral thus diluting the preference and the position of ordinary non-retail depositors. Since the FSCS is funded by the banking and financial services industry we wonder if this depositor preference is really required.
24. The retail bank is prohibited from taking on exposures to non-bank financial organisations. As a point of detail we would like to clarify when definitions are drafted that this should not apply to non-regulated finance or treasury companies within a non financial services group.
Competition / international competitiveness
25. With regard to competition in wholesale banking, we note that the Commission does not dwell on this in view of limited responses to its Interim Report. We continue to share the concerns the Commission set out in the Interim Report about this and note that the subject remains for later enquiry. Even for larger companies competition in banking is lacking and this may be reflected in the returns banks have in recent years expected to make on corporate banking
26. There is a risk that competitiveness of the UK wholesale banking sector may be damaged by the Vickers reforms in that the wholesale banking side would no longer benefit from the efficiencies of scale, the synergies, the valuable retail deposit base and some of the cross selling opportunities, thus setting them at a disadvantage to their overseas rivals. Given the market shares in the UK of the affected banks, there is a material risk that much of the cost of this would be passed on to customers rather than reducing bank returns on capital and staff remuneration costs as discussed in paragraph 19, above.
27. The cost and complications arising from the practical implementation of the ring fence should not be underestimated. There will also be material ongoing costs in terms of lost efficiencies and synergies. We would be concerned if during the transition customer service deteriorates for businesses in the UK.
28. We note too that it would not be difficult for a UK retail bank to provide its UK retail services from a European group company and passport its retail operations back into the UK and avoid the new rules. Anti avoidance provisions may address such a relocation but it is hard to see how that would easily comply with
71
European regulations. There may be perceived competitive advantage for new retail banks coming in from abroad that would not be subject to the new rules in course of time.
Smaller / mid-sized companies
29. Overall we recognise the argument that there is a cost/ benefit advantage in moving to a more robust UK banking structure, but we note that the benefit comes with some disadvantages for businesses and their ability to finance themselves. For larger companies any problems over financing can be redressed through raising new capital, borrowing from overseas banks or from accessing non bank sources of funding such as the international bond markets when circumstances allow. Many of these mitigating measures are not readily or at all open to SMEs and mid-sized companies.
30. It is important that any structural changes to the UK banking system consequent on the G20 sponsored changes or the report of the ICB be accompanied by significant and practical measures to encourage the flow of finance to those smaller and mid-sized companies.
4 October 2011
72
Written evidence submitted by Royal Bank of Scotland Group
Thank you for inviting us to respond to the Final Report of the Independent Commission on Banking. While we welcome the opportunity to give a preliminary reaction, it will take time for the full implications of the Commission’s recommendations to become clear. These will also be influenced by detailed rulemaking, market developments and customer and competitor actions.
I should say at the outset that RBS supports the direction of international banking reform. In that regard we are generally supportive of the ICB’s focus on capital levels and progress towards an effective resolution regime, even though this will be costly for bank shareholders and potentially for their customers and the economy. While we remain convinced that the Commission's proposals on ring-fencing will not achieve the benefits intended, we recognise the clear determination that they should proceed.
RBS set out its arguments in full in its published submission to the ICB, but one point bears repeating: ring-fencing will not create a “safe” ring-fenced bank and a “risky” non-ring-fenced bank. Many aspects of EEA retail and commercial banking permitted within the proposed ring-fence entail considerable risk, while many prohibited activities are routine, low risk services to UK corporates and institutions. In RBS's case, most of the losses incurred since the onset of the financial crisis have been ordinary commercial banking loan losses, not global markets losses.1
While our view of ring-fencing has not changed, we realise the Government has endorsed the main recommendations of the report. We will therefore work closely with Government and legislators to carry out the reforms arising from the Commission's report and to assist in the implementation of its recommendations. I hope that in this implementation the Government will be cognisant that the incremental impact on financial stability of the ICB’s final proposals should be measured not against the world of banking regulation as it was in 2007 but against the new regulatory framework that will soon be in place. The Basel III reforms to capital and liquidity are in train. The FSA and Bank of England are working on Recovery and Resolution Plans with each bank. There will soon be a new supervisory architecture as well as international crisis management mechanisms such as bail-in measures to ensure that equity and debt investors, not taxpayers, bear the burden of recapitalising failing banks. It is against this backdrop that the design of a new UK ring-fence should take place.
The delicate juncture for the economy and for the international financial markets also needs recognition, as the 1GB's proposals, even if not implemented for some time, already form part of market and company analysis and decision-making.
The ICB’s proposals will entail significant costs not just to the RBS Group but to the UK banking industry and to the UK economy as a whole. You will have seen a wide variety of analysts’ estimates confirming this judgment. This will present a significant challenge to the value of the taxpayer’s holdings in UK banks. In future, in light of regulatory change, it is likely that there will be a lower contribution from the financial sector to the economy than in the past or than would otherwise have been the case.
1 The assertion in Box 2.1 of the ICB's Final Report that most of RBS's losses arose from its global markets activities is incorrect. 73
As I said at the outset, RBS supports the direction of international banking reform. We also support the ICB’s recommendations relating to competition in the UK banking market. We think it unlikely, however, that the proposed UK ring-fence will add to financial stability in a cost-effective way.
6 October 2011 74
Written evidence submitted by Barclays plc
1. Executive Summary
1.1. Publication of the Independent Commission on Banking’s Final Report represents a welcome step towards the regulatory certainty that banks need in order to focus on serving their customers and clients and, thereby, fostering economic growth.
1.2. We support measures aimed at balancing enhanced financial stability with growth. We see resolving ‘too big to fail’ as a key part of that, and we welcome measures to achieve it.
1.3. We remain un-persuaded that a retail ring-fence offers enhancements to financial stability and believe it has, at best, marginal benefits as a resolution tool over and above reforms already in place, underway, or in development, including the improvement and alignment of resolution plans and powers and improvements to loss absorbency requirements for banks at the global level.
1.4. There is understandable, but considerable, ambiguity around how the ring-fence will operate, the impact that it will have on bank costs, and the wider costs to the economy. This uncertainty, arising directly from the Final Report, exacerbates what is already a difficult market environment for banks globally given sovereign and global growth concerns. Clarity must be obtained through the legislative process, and the Treasury should have an explicit objective to minimise the risks of creating unintended consequences as specific rules are designed.
1.5. By its own admission, the Commission’s recommendations go significantly beyond international regulatory standards; UK based banks therefore will not be operating on a level playing field. We recognise that the Commission has considered this impact and made some efforts to mitigate this, but it has not eliminated it.
1.6. Barclays supports the recommendations to improve competition, particularly enhanced switching for customers, and is participating in the new industry commitment to make improvements by September 2013.
1.7. The approach to implementation must now be practical and pragmatic. If the financial stability recommendations set out by the Commission (including the ring-fence and capital requirements) are pursued, this should happen in a way that minimises the cost to the economy and the impact on the competitiveness of UK banks.
1.8. The timescales for implementation reflect the practical reality of putting in place the legislation that will enable what are complex and far-reaching structural reforms. Attempting to implement those reforms without primary legislation would risk destabilising the sector and undermining the intention of the reforms. 75
2. Introduction
2.1. Publication of the Final Report represents a welcome step towards the regulatory certainty that banks need in order to focus on serving their customers and clients and fostering economic growth. However, the recommendations constitute significant and far- reaching reforms with a high degree of ambiguity remaining as to final design, implementation, precise impact on bank costs, and the consequences for the wider economy. Further careful consideration of the proposals is therefore required, and we welcome the Treasury Committee’s continued scrutiny of the recommendations to ensure that the correct reforms are implemented in the right way.
2.2. The final recommendations put forward by the Commission are broad and complex. Barclays is still considering those recommendations, and our submission here represents our preliminary views only. This submission first looks at recommendations relating to financial stability, then considers proposals to improve competition, before examining the approach to, and timescales for, implementation.
3. Financial Stability
3.1. Much has changed since the financial crisis both within banks and across the regulatory landscape to make banks safer and to reduce the impact of bank failures. Barclays Core Tier 1 ratio has broadly doubled since 2007 from 4.7% to 11%; our leverage is down by one third, from 33x to 20x; and our liquidity pool (of cash or cash equivalent instruments) has grown from £36bn in 2008 to £145bn. For the industry: capital and liquidity has increased; the term of wholesale funding and the volume of liquid assets have increased materially; risk management and governance arrangements have improved; recovery and resolution plans are under development; deposit insurance arrangements are being strengthened; and, the quality of supervision has been enhanced.
3.2. These changes have significantly enhanced the stability of the UK based banking system. However, each adds to the cost of doing business and therefore to the cost and potential availability of credit to businesses and consumers. This is exemplified by the fact that UK banks average Return on Equity was 7.5% for full year 2010 (excluding RBS for which there is no publicly disclosed Group RoE). Therefore, it is important to continually review the aggregate cost to the economy of the changes placed on the banks.
3.3. Further reform is being implemented or is under consideration. In particular, reforms:
• to increase capital further for systemically important institutions;
• to align resolution planning activities and powers across borders, and ensure the relevant authorities have powers to impose losses on shareholders and creditors rather than rely on taxpayers; and,
76
• to improve the infrastructure supporting key trading markets to make it more resilient.
Any incremental, UK specific reforms should be required to demonstrate significant additional benefit over and above the cumulative effect of those reforms at an acceptable cost to the economy.
3.4. Barclays welcomes the Commission's recognition that the universal banking model offers benefits to financial stability and the wider economy and that, for these reasons, full separation is undesirable.
3.5. However, the Commission argues that there is a strong case for some form of ex-ante structural reform on the basis that it will make it easier to resolve banks that get into trouble and to insulate critical functions of retail banks from external shocks. That is the premise underlying the proposed ring-fence. Barclays does not agree with the Commission’s analysis for the reasons set out below.
Retail Ring-Fence
3.6. The Commission argues for a retail ring-fence on the basis that ex-ante structural separation of this sort would isolate those banking activities where continuous provision of service is vital to certain individual customers who generally have no alternative to their main provider. The Commission argues that ex-ante separation of these activities would ensure that at the point of non-viability of a bank, these activities could more easily be separated and continuity of service ensured without taxpayer support.
3.7. Regulatory changes introduced since the financial crisis and currently in development1 at a global, regional (EU), and national level have materially decreased the likelihood of a bank failing and the impact of a failure by making them easier to resolve. This includes Resolution and Recovery Planning (so-called RRPs or Living Wills) and so-called bail-in of debt – which significantly adds to the potential loss absorbency of a firm and provides the capital required for an orderly recovery or wind-down of a business.
3.8. Given the international nature of financial markets, it is important for the UK that all banking markets are stable and secure. We therefore welcome moves which will see these reforms implemented at an international level and are actively participating in the dialogues that will produce that outcome.
3.9. We do not believe that a retail ring-fence will materially further enhance the stability of banks. To the contrary, in some cases, such structural separation could have a destabilising effect. In particular, the ring-fence will disrupt the flow of liquidity within a bank, which, at the extreme, could result in a bank failure which would not otherwise have occurred. The disruption to free flows is likely to put an increasing burden on the Bank of England as ‘Lender of Last Resort’ to provide liquidity support during a crisis. Subject to
1 For a full list see Barclays Response to the ICB Issues Paper, page 11. 77
how the design and operation of a ring fence are finalised, the capital flexibility might also be constrained.
3.10. The objectives set out by the Government for the Commission would be best achieved through firms implementing a combination of credible Recovery and Resolution Plans and operational subsidiarisation (see p5) to enable continuity of service, set within the context of a wide and effective resolution regime. We welcome the Commission’s recognition of the importance of such measures but believe they have underestimated the stability benefits that these combined reforms will deliver.
3.11. Implementation of a ring-fence will add to the cost of UK banking operations. Higher funding costs, for example, will have an impact on the cost and availability of lending to customers. The competitiveness of UK wholesale banks will also be affected if one or more of the measures are implemented unilaterally. Therefore, if a ring-fence is to be introduced, it is vital that it is implemented in a way that minimises the cost of implementation and only after careful consideration of such costs and potential benefits.
3.12. The cost of implementation of the ring-fence will depend on the precise detail of the design and operation of the ring-fence. The high level principles for the operation of the ring-fence, articulated in the Commission’s report, lack sufficient detail to enable a full understanding of the practical implications of how the ring-fence will function and so it is not yet possible to confidently model its cost.
3.13. Whilst Barclays preliminary assessment suggests that the flexible approach to the design of the retail ring-fence could help mitigate some of the expense of a ring-fence (flexibility which should be enshrined and protected in legislation), a large number of ambiguities and variables remain that will impact the way in which the ring-fence is ultimately implemented and, therefore, its cost.
3.14. For example, there is currently insufficient detail to reach an informed view on:
• The precise nature of third party relationships that must be adhered to between the parent and ring-fence, which will significantly affect banks’ ability to efficiently manage their balance sheet and provide liquidity to the retail ring-fence both in time of crisis and during ‘business as usual’ activity.
• The interplay between loss absorbing capital requirements and (as yet undefined) limits on parent and wholesale funding which could effectively establish a prescriptive funding structure for the ring-fence.
• The precise definition of EEA customers to be used to construct the ring-fence.
• The relationship between the ring-fence and any operational subsidiary(ies) that are set up to ensure that all aspects of the entity are resolvable.
78
• The combined implications of a minimum amount of loss absorbing capacity; bail-in; and depositor preference on the funding basis of the retail ring-fence.
3.15. It is important to note that whilst there is agreement internationally on the need for stronger resolution tools, the UK is alone in considering ring-fencing.
3.16. Barclays disagrees with the notion put forward by the Commission that the increase in funding cost of the unsecured finance in the wholesale division of banks will be due to the removal of so-called ‘state support’ notches provided by some Credit Rating Agencies. Analysis shows that there is no correlation between funding costs and such notches. Rather, funding costs are driven by underlying bank strength expressed by their base ratings – Barclays is able to fund itself more cheaply than many banks which receive more support notches for example. Because these reforms will remove diversification benefits and segregate certain assets and liabilities, it is likely that funding costs will increase because the underlying strength of the business units will be diminished and unsecured creditors to the non-ring-fenced part of the bank will become structurally subordinated.
3.17. Barclays believes that no bank should benefit from a taxpayer guarantee; the aim of these reforms is to enhance financial stability by making banks resolvable, not to enshrine taxpayer support to certain types of banks. If a market perception builds of an explicit guarantee for the retail ring-fence, that will create highly undesirable customer behaviours that, especially in a crisis, could obviate the benefit of the design flexibility that the Commission has provided. That will arise because customers may elect to redirect their funds from the non-ring-fence entity to the retail ring-fence in the midst of a crisis in order to benefit from the perceived government guarantee with a resulting impact on the liquidity of the firm.
Operational Subsidiarisation
3.18. The Committee will be aware that Barclays considers operational subsidiarisation (whereby the part of a bank’s infrastructure that is vital to ensure ongoing operation of critical functions is placed into a separately capitalised and insolvency remote subsidiary) to be a vital part of recovery and resolution. Operational subsidiarisation ensures that the critical functions (the same as those defined by the Commission) of a bank are able to continue to operate in the event of a bank becoming non-viable. The imposition of a retail ring-fence does not change our view. Given the importance we attach to it, Barclays remains committed to implementing operational subsidiarisation by 2013. There is significant ambiguity in the Final Report as to how such subsidiaries will interact, and we look forward to obtaining clarity from HM Treasury, as quickly as possible, so that we can continue to execute our resolution planning activities at pace.
Loss Absorbency
3.19. The Commission’s recommendations on loss absorbency go well beyond standards yet to be agreed internationally through Basel III and explicitly anticipate reforms in the EU on crisis management and globally on resolution planning. If these reforms are to be 79
implemented in the UK in advance of those regional and global reform movements, it is vital that UK authorities work closely with the industry to ensure that similar changes are introduced as quickly as possible on an international basis.
3.20. One other area that caused considerable confusion, in the immediate aftermath of the publication of the report, was in the language relating to the Commission’s recommendations on primary loss absorbing capital (or PLAC) – especially its use of the term “bail-in bonds”. Specifically, the recommendation for UK banks to hold a minimum of 17 to 20% PLAC was widely misunderstood. Many compared this to the so-called “Swiss Finish” and assumed the UK was considering the same reforms. However, the ICB recommendations related to their expectations that the international authorities will put in place a so-called statutory bail-in regime under which any wholesale unsecured finance held by banks would be subject to loss in the event that any bank becomes non-viable. In such circumstances, the total loss absorbing capacity of those banks will likely well exceed the recommended minimum PLAC, as the Commission illustrates.
3.21. Barclays agrees with the principle of extending the PLAC to cover unsecured creditors to enhance the ability of a bank to absorb losses. However, there are considerable ambiguities in the Commission’s recommendations relating to the secondary bail-in powers that are to be granted to the resolution authorities. Their recommendations appear largely consistent with Financial Stability Board (FSB) proposals granting resolution authorities primary bail-in power to impose losses on long-term unsecured debt, with secondary power to impose losses on all other unsecured liabilities – if required. However, including certain liabilities into secondary bail-in (e.g., uncollateralised derivative positions) might create countercyclical effects prior to the execution of a primary bail-in that put into question the purpose of the bail-in or the feasibility of resolution. The consequence of these recommendations needs significant and careful consideration.
4. Competition
4.1. Barclays fully supports actions to increase competition in the UK banking industry. The switching and transparency initiatives recommended by the Commission are currently being executed by the industry, and as an individual institution we commit to continuing to develop and implement new ways to ensure that our customers’ lives are made much easier.
4.2. Although the Report stops short of recommending an immediate reference to the Competition Commission for a market investigation into retail and SME banking, it does advocate that this should be considered in 2015 if such a reference has not been made by then. We believe this would be an unnecessary step given the findings of the Commission and all of the prior studies of competition that have been conducted on the UK retail market in recent years.
4.3. Further, the Report recommends that the FCA should have a primary duty to promote competition in addition to enhanced competition powers, and that the current proposed statement of objectives should be strengthened to reflect this. The aim seems to be to 80
create an economic regulator. We feel that this would be highly unusual and an unprecedented step in the financial services sector.
4.4. The Commission does not appear to have taken account of the fact that the proposed structural reforms are likely to have a knock-on impact on competition in banking. In particular, the retail ring-fence and associated increase in capital requirements are likely to increase costs for consumers and raise barriers to entry for new competitors as they will effectively represent new fixed costs of entry.
5. Timescales
5.1. Barclays regards the proposed implementation timelines set out by the Commission as pragmatic given the range of steps that must now be taken (including new primary legislation) and the time it will take to complete each. While that timeline may look longer than necessary, these are fundamental reforms to the industry, and we believe the time indicated is necessary to allow careful assessment of the recommendations. Their full and careful consideration will allow a thorough cost benefit analysis to be conducted to ensure that the measures balance the benefits that they bring to financial stability with the cost to the economy.
6. Implementation
6.1. Barclays notes the Government’s stated intention to include elements of the Commission’s recommendations in the forthcoming Financial Services Bill. There is a strong case for including clauses within that Bill that gives the Financial Conduct Authority (FCA) a statutory objective for competition. However, it is important that there is alignment between the FCA’s competition objective and existing powers held by competition authorities such as the Office of Fair Trading (OFT) and Competition Commission.
6.2. Because the UK authorities already have considerable resolution powers granted through the Banking Act of 2009 and the special resolution regime within that, there may be opportunities to refine that existing legislation through the Financial Services Bill to deliver the Commission’s related recommendations. However, the implications of depositor preference require careful consideration because there could be material unintended consequences unless this is designed appropriately, particularly in conjunction with the other reforms. Such a reform will have far reaching (and potentially extraterritorial) consequences on the nature of insolvency law in the UK and customer behaviour, so time should be taken to ensure that legislation is drafted carefully and there is sufficient consultation to ensure that unintended consequences do not undermine the intention of the reforms.
6.3. The significance of the Commission’s recommendations; their potential impact on the UK economy; implications for UK banks’ ability to compete globally; and the ambiguous, under-developed nature of many of the recommendations require a robust and thorough consultation process.
81
6.4. This should include a rigorous cost benefit analysis on the recommendations ahead of any legislation, explicitly taking into account the range of other reforms already delivered, underway, or under development.
6.5. The Commission’s recommendations have the potential to reshape the banking industry for generations, and it is essential that adequate time is taken to provide a proper statutory footing for those changes and to allow full consideration of their impact on the UK’s fragile economy today and in the years and decades to come.
7. Conclusion
7.1. These represent Barclays initial thoughts. We look forward to working with HM Treasury to clarify the ambiguity in the Commission’s Final Report and to identify a practical and pragmatic approach to achieving the Government’s desired objective with respect to financial stability while preserving the ability of UK banks to compete effectively inside and outside of the UK so that they are able to support fully their customers and clients and, thereby, contribute to economic growth.
October 2011