Jim Ford, Partner Consultant at CGI, speaks with us about the ring-fencing measures contained in the secondary legislation of the Banking Reform Bill
What are the core activities permitted by ring-fenced banks?
Ring fenced banks are mandated to offer account facilities for deposits to retail and SME customers. The criteria for SMEs is that annual turnover must be no more than GBP6.5 million or balance sheet size is GBP3.26 million or less or there are less than 50 employees and payments and to provide overdraft facilities to these clients as well.
What activities are prohibited?
For the sake of accuracy it is best to say here that the ring-fenced bank cannot deal in investments as principle, in other words it cannot engage in proprietary trading activities where it would incur market risk. The government doesn’t want the bank to take risk in the markets. The bank can offer simple derivative products such as interest rate swaps to its customers or use derivatives to manage its own balance sheet risk. The definition of an SME as defined by the government as <6.5 million turnover.
Banks will have to decide where to place their corporate customers. Larger ones will potentially buy a wide range of services from their banks s, some of which may only be available from the non-ring-fenced bank. These corporates could maintain account relationships with both sides of the fence or they could maintain their account relationship with the ring-fenced bank. In the latter case the ring-fenced bank could act as an agent for the non-ring-fenced bank for the more complex products. Whatever decision is reached there will be complications and challenges
How can ring-fenced banks prepare and have they already begun preparation?
They have definitely started getting ready. They have been speaking with the regulators and the Treasury and reviewing the impacts on their own business models. They are still trying to decide how large the ring fence will be, what assets will be included and what assets will excluded.
If I was a bank preparing the first things I would look at are the legal, operational, architectural and regulatory reporting needs as well as the needs of my clients. Looking at your clients you’ll have to see which clients will sit on which side of the bank. Then there is the question of “What are the practical implications of those that choose to work with both? (I have said this part above, but I will leave you to decide where you want to put stuff)”
Payment system membership will be a key area of consideration. The creation of what is in effect two new banks means that both sides will need to consider which of the UK payment systems they will join. It is likely for example that the non-ring –fenced bank will join CHAPS given the nature of its business. However it is not clear whether it will join any of the others. However it may need occasional access to the other and it needs to consider how this will be achieved. The ring-fenced bank may well take over the existing payment system memberships. Employee concerns: Banks will need to consider people and premises’; which employees in the ring-fenced bank and the non ring-fenced bank? What are the implications? One serious operational model under consideration is the creation of an operational subsidiary which would service both the ring-fenced and the non-ring-fenced bank. This will also have major implications for people and premises. Will it take over people and premises? Will it just be back office staff or will it be other areas as well. What systems and platforms will it have? The operational subsidiary will also have to be sufficiently funded and capitalized, particularly if one side of the ring-fence goes down. It will be imperative that it continues to process payments for example.
Credit limits will be another area that will face potential impact. If, for example some corporates do end up being serviced by two sides of the bank, what will be the impact on credit appetite? Loan related documentation such as collateral agreements, ISDAs etc. may well have to be reviewed.
Banks from my experience are not looking at operational issues on a detailed at this stage. This is mainly because the bill has not provided detailed operational guidance at this stage. This will become clearer when the legislation is converted into regulation which is not due to start until the latter half of 2014 Banks will need to be operational by January 2019.
In what ways are agency banks impacted?
Agency banks may face a challenge as a result of ring-fencing
The ring-fenced banks will have a cap placed on their overall payments related exposures to financial institution clients which amounts to 10% of capital. This may lead to the ring-fenced banks reserving their credit lines for their larger banking clients while reducing or eliminating their lines for smaller banks of which agency banks may form a large part. So we may see agency banks struggle to get payments out the door if they don’t have sufficient funds on their account. They could go to the non-ring-fenced bank, but they may not be seen as profitable enough. This may lead them to join the payments systems directly. This has operational, cost and risk challenges for the agency banks. Agency banks could be forced out of their relationship with larger banks and the larger banks may also think I have these agency banks and the revenues aren’t huge, they may raise their prices or decline the business. This again pushes the agency banks off to join a payments scheme themselves.
What are the technology challenges you see banks facing?
From my perspective you have a number. For the last few years we’ve been moving towards a central hub and now we are looking at operational separability. You may have to rip architecture apart where as we’ve been trying to put them together at this point. This will impact on platforms, applications and databases.
If banks adopt the operational subsidiary model which platforms and systems go into it? Where there is duplication of architecture across the bank, is this an opportunity for rationalization and sunsetting? In the case of the retail and SME client’s data will often be scattered across multiple systems and databases. How will all that be captured? Product platforms for retail and SME clients tend to be separate. How will that be captured and managed in the future.
You also have the issue of what happens when the SME grows. Will it stay in the ring-fence? How will that change be captured and monitored?
The ring fenced bank will have to do its own regulatory reporting. If you have clients on both sides will you be able to have a single customer view or will they have to be serviced in isolation??
What about the impact of Dodd Frank and other regulations banks are already facing?
If you are looking in the UK you have had the Living wills issue that many banks have produced a first version of..
The Likened review which is the European version of ring-fencing may possibly complicate the issue. This is because in the current proposal national regulators will have a lot of discretion as to how far their banks will have to ring-fence their trading assets away from the rest of their business. This could vary the ring-fence from country to country which for UK banks with offices in Europe could mean varied ring-fences
Dodd Frank will require UK banks with a US presence to carry out re-structuring and there may be lessons that could be learned from there.
Are there any benefits to the ring-fencing?
One area is banks have been talking for years about data management and using data effectively. This gives the bank a good opportunity. There may be opportunities in cloud architecture.
The other advantage compared to traditional investment banking, is it may drive banks to provide innovative products and a higher level of customer service.
What products/services does CGI offer that may assist?
As the 5th largest IT services company in the world, CGI has in-depth experience of major operational and technological transformation projects of a similar nature to ring-fencing. Indeed we have carried out a number of these for UK banks. In our consulting practice we have tools, methodologies and people to help banks plan as well as design the optimum target operating model for the new ring-fencing infrastructure. This includes assessing the costs and benefits arising from various scenarios. Our solutions architects, business analysts and data analysts can all provide banks with expert assistance in the implementation of all the ring-fence changes. In short CGI can provide a full end-to-end service that will help banks through the whole ring-fencing process.
- CGI has examined the legislation in detail. Read their complete report and find out how to get the most from your IT strategy “Change and consequence: Examining the impact of ring-fencing on the UK banking industry”.