Independent Commission on Banking Report

Below are what I consider to be some of the more important highlights of the Independent Commission on Banking released last Monday (April 11, 2011).

Reform on Capital Standards:

“The Commission’s view is that the 10 percent equity baseline should become the international standard for systemically important banks, and that it should apply to large U.K. retail banking operations in any event.”

John Viker - ICB Chair - @The Wall Street Journal

Proposed Ring-Fencing of Retail Banking:

“It is open to debate whether a retail ring-fence would give more or less banking stability than full separation between retail banking and wholesale and investment banking. It would be less costly to banks because they would retain significant freedom to transfer capital. The required U.K. retail capital level would constrain banks only when they wanted to go below it to shift capital elsewhere, say to their wholesale and investment banking operations. Rather than pursuing more radical policies towards capital or structure, the approach outlined above is a combination of more moderate measures.”

Commission’s view on Lloyds Banking Group Plc and its Branch/Asset Sales:

“The Commission therefore suggests that the Government seek agreement with Lloyds Banking Group to enhance the divestiture substantially. An enhanced divestiture could give an improved outcome for competition, both by reducing market concentration and by strengthening the divestiture’s ability to act as a challenger.”

The commission’s proposals are aimed at increasing competition. At least two questions come to mind: firstly who is interested to buy these branches? Secondly how can it increase competition if the buyers are the same large groups already dominating the U.K. banking market? The report adds:

“However, if a substantially enhanced divestiture does not result, there could be a strong case for the competition authorities to conduct a market investigation of the personal banking and SME markets in the U.K.”

U.K. Banks - @Telegraph.co.uk

Possible combination of Lloyds Branches and Northern Rock:

“In particular, the commission would not want to preclude the possibility of Northern Rock Plc being used to strengthen competition at a national level, for example by being combined with the Lloyds Banking Group divestiture in order to strengthen a new challenger bank.”

Commission’s view on the Cost of Capital and Ring-Fencing of Retail Banking:

“On balance, the commission’s current view is that the private costs of a U.K. retail ring-fence may be material but are likely to be much smaller than the 12 billion pounds ($20 billion) to 15 billion pounds estimate.”

Although this report is a step in the right direction, it is less than what was already expected, and perhaps discounted, by most observers. This is reconfirmed by the pursuant relief rally in banking shares in reaction to the report.

Therefore, concerns remain that by the time these proposals, or what will remain of them, are implemented, they’ll be watered down to the extent that they are no longer meaningful.

Unfortunately, the commission set a rather low bar for negotiations and it is going to be quite difficult to push for any further reforms in the final report. The banking industry will most certainly lobby very hard against any proposals that may raise its cost of operations or capital.

There are many issues and details that are not fully clear in this report. I will present a more detailed analysis of the report and some of the remaining issues and concerns in the coming week.

Author: Dr. Peter Buzzi