Ringfencing is unhealthy for UK banks and clients | USAEMALL.com

Stay informed with free updates

Simply sign up to the UK financial regulation myFT Digest — delivered directly to your inbox.

The writer is founding partner and CEO of Atlas Merchant Capital and former chief executive of Barclays

I’m writing this in New York. If I take even a short journey from my desk, I can visit the branches and offices of more than a dozen banks. Some are global household names, others are smaller regional corporate and retail banks. All of them are thriving. They compete and innovate and grow and attract investment on a daily basis. 

That vibrant, dynamic banking sector is a vital part of US economic success. Sadly, neither that economic success nor that thriving sector have equivalents on the other side of the Atlantic.

What’s different about British banks? It’s not that they lack ambition or talent — the UK banking sector enjoys great leadership hungry for global success. No, the difference lies in a regulatory regime that has increasingly harmful consequences for the sector, the UK economy and potentially even for financial stability. 

The centrepiece of this regime is ringfencing, the separation from other operations of domestic retail banking operations. It’s a classic example of how regulation drawn up with the very best of intentions ends up doing more harm than good. 

Ringfencing has its origins in the global financial crisis but it wasn’t put in place until 2019. In the six years that have followed, it has become clear that it is bad for customers, bad for the sector and bad for stability. 

The main effect of the rule is that banks are required to invest their ringfenced deposits into domestic assets. Ringfenced banks with these “trapped” deposits are required to chase the same domestic assets at lower and lower spreads. That consolidates the dominance of big banks and weakens the competition that drives innovation and attracts investment. 

A Bank of England paper on ringfencing in 2020 concluded that “ring-fencing is reported to have contributed to the exit of smaller lenders from the UK mortgage market. The increased market power of large banks could lead to more expensive credit over the longer term.”  

This isn’t just a problem for customers, it’s a problem for the sector.

If you want proof of ringfencing’s unintended consequences, look to the UK government’s rationale for increasing the ringfencing threshold to £35bn from £25bn. Tulip Siddiq, then City Minister, said last year, “The reforms will improve competition and competitiveness in the UK banking sector and support economic growth.” 

Ringfencing also increases the risk of the very thing regulation is supposed to prevent — systemic instability. That’s because the policy pushes banks outside the ringfence to bear more risk. Unable to compete with the big ringfenced players for the best assets on the most attractive terms, smaller competitors are forced to take on more and more higher risk assets.

Worse, most of this credit is extended to British customers. As a direct consequence of ringfencing, corporate loans on UK bank balance sheets are now concentrated on UK corporates, specifically on companies reliant on UK banks to secure funding. Alongside the other domestic assets on their balance sheets, this represents a perfect recipe for financial instability and systemic risk.

Ringfencing has reduced UK banks’ geographic diversification, in effect putting all of Britain’s eggs in one basket. 

These real and serious risks are all the worse when you recall that ringfencing was supposed to solve the so-called “too big to fail” problem, by ensuring that taxpayers would never again have to bail out depositors, because banks would be protected from existential risks.

In reality, the hyper-concentration in UK domestic assets that ringfencing promoted does not make financial institutions more secure. And the increased reliance of borrowers does not reduce systemic risk.

Achieving balance in the regulatory priorities of risk management and growth is difficult in such a complex sector as banking. But for many years, British regulators were supportive of fostering innovation and growth. That was the backdrop when I was developing Morgan Stanley’s fixed income business in London and then building Barclays Capital into a global investment bank.

This is not about turning back the clock. But Britain needs regulation that ensures it is best placed to benefit from the fundamental interplay of a thriving economy and banking sector. The intentions behind ringfencing were noble. But the awkward truth is that the regulation is doing more harm than good. For the sake of Britain’s consumers, economy and stability, it’s time to think again.