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Not enough discussion has taken place about how banks should ring-fence different parts of their operation




By Richard Goold, Executive Director, and Alistair Catto, Principal, at transformation consultancy Moorhouse

Richard-GooldThe financial services sector as a whole is experiencing an enormously challenging time. In the face of multiple pieces of legislation from around the globe, compounded by often contradictory requirements, the industry is having to cope with an enormous amount of pressure and change.

This is especially true in the UK’s financial sector. A great deal of discussion has taken place recently concerning the ring-fencing of banking institutions and the separation of their operational entities. The UK Chancellor, George Osborne, has even stated that such a fence should be “electrified” with the threat of severe sanctions. If banks do not fully separate their retail and investment banking divisions, they face being split up by fresh government powers.

In reality, how easy is it for banks to carve out these two seemingly different parts of their operation and what implications does this have for customers? While the rhetoric is convincing and clearly communicates the urgency and drive from policy makers to challenge the banking industry to change, little has been said about how such a separation should be achieved.

Ring-fencing comes with its own set of problems. It will likely bring uncertainty for investors, and as a result banks may find it difficult to raise capital. This will compound the lending problems the sector is facing. A number of international regulators have questioned the need for ring-fencing as opposed to strengthened balance sheets, stating higher capital and liquidity requirements are more important for stabilising banks than the separation of proprietary trading and deposit-taking business. Whether intended or not, there is a risk that this move only compounds the existing perception of constricting regulation across the industry.

What is being suggested is a move away from the Universal Model of banking which is deeply ingrained within most diversified European banks. While the ring-fencing approach has been challenged as a strategy that may well stifle capital markets – and in fact deliver little in terms of risk mitigation – the critical aspects of exactly how the ring fence could be put in place has not been sufficiently debated.

Looking below the veneer of some of the recent legislation affecting UK banks, it’s self-evident that the primary focus is to ensure that these organisations better serve their customers, and reduce the risk faced by them and the taxpayer in the event of a crisis.There have been many obvious examples of corporate failure that have led to the call to split retail and investment banks. However, it is debateable whether this kind of ring fencing would in reality have really prevented either the UK bank bailouts or the collapse of Lehman Brothers. Most of the evidence points to poor decision making and reckless risk taking having a far greater impact.

Clarity on the required approach to ring-fence will be critical to ensure that banks can implement suitable regulatory mechanisms while maintaining Business As Usual (BAU) activities. Ring-fencing would most likely be achieved by segregating specific asset classes and liabilities into separate companies. While this is primarily a legal and financial treatment, there are likely to be wide ranging operational changes required to support the delivery of a ring-fenced business, compliant with requirements which genuinely supports a business that has reduced the threat of “moral hazard”.

In reality diversified banks dealing in both retail and investment banking would have to revisit their operating models and change their entire corporate structure dramatically to achieve the aims of the regulation, to do this without impacting the customer experience must be their first priority. By taking a customer centric view of the change and understanding how best to serve their customer base, the banks may well be able to gain competitive advantage in the short term during a period of highly disruptive change. Ring-fencing has to ensure that the interest of customers is paramount without adding an increased cost (or bureaucracy) to existing services as a result. This will, in essence,force banks to set up separate organisations under the same brand. Alistair-Catto

Some may question whether the ring-fencing of banks provides any benefits over the total separation of retail and investment banks. This highlights the need for the right governance; both from a compliance perspective but equally from an ability just to do business. This will require large-scale behavioural change for banks and whether the ring-fence is a success will be heavily dependent on the right level of regulation. Furthermore, banks will need to look at this agenda as part of the wider mix of other (current) legislation. A piecemeal approach, reacting to individual pieces of legislation, will ultimately fail. To maintain efficiency and better manage the wider legislative agenda, an over-arching perspective is vital and will prevent duplication of costly work.

To gain advantage from such a significant seismic shift in the regulatory environment will require banks to start acting sooner than they might imagine, the deadline of 2019 for ring-fencing will present challenges to many, and those banks that act fast to define the portfolio of change required and begin to drive strategic solutions will be those that profit most in the new world order.

This will be tough. Financial organisations are already struggling to cope with the influx of new regulation. Research undertaken by Moorhouse in 2012 shows that the increasing pace and volume of regulatory change means organisations are unable to focus on other strategic priorities that will help grow their businesses. The survey of 130 senior executives and board-level Directors in the UK FS industry, found that 83 per cent feel regulatory change is affecting their ability to deliver day-to-day operations and services and almost half (48 per cent) say the regulatory agenda is negatively affecting their competitive advantage. Well over three-quarters of those surveyed felt their organisation would have to change its business model in order to thrive over the next 3-5 years, with almost two-thirds reporting this change would need to be substantial or fundamental.

In what is already a very challenging environment, banking organisations will need to plan very carefully any additional work to separate or ring-fence different sides of their business.

To request a copy of the “Too much change?” report on the UK financial sector, visit





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