Ringfencing will force the restructuring of banks. Will treasury departments join the new “investment” institutions or stay with the safer “utility” businesses. Either way, information released so far has given few clues about how the banks intend to split.
Ring-a-ring o’ fences
A pocket full of guesses
A-tishoo! A-tishoo!
A bank falls down
Popular legend has is that the Ring-a-ring o’ roses nursery rhyme refers to Europe’s great 17th Century health crisis, the Black Death. The more recent aphorism: “when America sneezes, Europe catches a cold” neatly summarises the origins of the early 21st Century’s great financial crisis. Bank ringfencing, then, is part of the UK’s strategy to inoculate this country against the next great economic plague.
Pretty much the whole Western world has implemented or is contemplating bail-in as a strategy for treating diseased banks in future. This should limit the need to bury the patient (closing banks is never good for the economy) or to inject it with billions of life-saving taxpayers’ cash. But bail-in remains untested, except in the smallest and simplest cases, and there is some scepticism over whether regulators could really bail-in a large bank. In the UK we are therefore going one step further to convince markets that the bail-out era has been buried for good by introducing bank ringfencing.
So, at some point in 2018, the largest UK banks will ringfence their essential banking functions into a separate company from their riskier activities. Only this ringfenced bank can accept deposits from and make loans to individuals and small businesses; while only the remainder non-ringfenced bank can indulge in proprietary trading of securities and derivatives. A few activities, including simple banking services for large companies and local authorities, can take place in either bank, potentially giving treasury managers a choice of where to invest.
So, there are likely to be four new UK banks to add to your counterparty lists, with different credit risk characteristics and paying different interest rates, but with confusingly similar names. They will still be called Barclays, HSBC, Lloyds, NatWest and RBS. But the word “markets” in the bank name will be an indication that you are looking at a non-ringfenced “investment” or “casino” bank, whereas if it has “UK” in the title that will probably be a ringfenced “retail” or “utility” bank.
Guesses
The “pocket full of guesses” in my rhyme refers to the banks’ slowness in publishing their detailed ringfencing plans. There is the impression that the ringfenced bank will have lower risk assets and proportionally more capital than the non-ringfenced bank, but the exact degree of this is unclear. More certain is that ringfenced banks will have fewer non-preferred unsecured creditors to share losses around than their counterparts. And of course there is absolutely no chance of a government bail-out for the investment bank. Together this means that bail-ins should be rarer, but larger, at ringfenced “retail” banks.
The choice for wholesale depositors in future will therefore be between the maybe twice-a-century life-changing event in a retail bank, and suffering maybe once-a-decade more moderate pain in an investment bank. But for investments made today at some banks, it’s anyone’s guess as to which entity you might end up in.
Slow to react as always, rating agencies are only now starting to build ringfencing into their credit ratings. It appears in most cases that the retail bank will be better rated than their sibling investment bank, due to the agencies’ greater focus on probability of default than loss given default, but only by one or two notches.
So, will local authorities avoid the supposedly riskier investment banks like the plague? Or, will they be drawn in by the lure of higher interest rates and structured products not offered to retail customers of the poorer relation? Will the next bank failure be a Co-op style retail banking crisis or a Lehman Brothers style investment banking one? The doctor wants to conduct more tests on this patient before giving his diagnosis. But in both medicine and finance, the best advice is always to hope for the best while preparing for the worst.
David Green is Client Director at Arlingclose Limited. This is the writer’s personal opinion and does not constitute investment advice.
