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By Roger Davies, Principal Consultant, EA Change Group

The British government has confirmed its intention for ‘ring-fencing’ to be implemented for the larger UK banks from 1st January 2019. Such ‘ring-fencing’ had been proposed by the Independent Commission on Banking (ICB) to boost financial stability and help combat the ‘too big to fail’ (TBTF) dilemma. Separating deposit and lending functions for individuals and SMEs from the ‘casino’ operations of investment banking was seen as essential to protect the UK taxpayer, though the ICB rejected full separation on grounds of cost, synergies and legality. Subsequently, a ring-fencing requirement was included in the ‘Financial Services (Banking Reform) Act 2013’ and the PRA (Prudential Regulation Authority) is now required to produce the relevant policy and rules to govern its implementation.

Roger Davies, ea Consulting Group

Roger Davies, ea Consulting Group

To this end, consultation paper CP19/14 ‘The implementation of ring-fencing: consultation on legal structure, governance and the continuity of services and facilities’ was published in October 2014.  A threshold limit of £25 billion in core deposits has been set to invoke ring-fencing although all building societies and credit unions will be exempt. The PRA proposals demand the legal separation of the Ring Fenced Bodies (RFBs) as far as is practicable. If, as likely, within a larger banking group the RFB must have independent executive management and deal with other group concerns strictly on a third party basis. Most importantly, a RFB must never be dependent for its solvency or liquidity on the financial health of the group. The ring-fencing proposals do not distinguish between proprietary trading and other trading such as securities market-making with both banned for an RFB. CP 19/14 drafts new rules in the areas of governance, risk management, internal audit, remuneration and HR policy to enable an RFB to take decisions independently of other group entities. More specifically, RFBs should have their own heads of risk management and internal audit with sufficient resource in each function. The chair of an RFB must be independent as must at least two-thirds of an RFB’s board.

Although CP19/14 requests responses by 6th January 2015, urgent action needs to be taken by all banks expecting to be subject to ring-fenced in 2019. PRA has requested a preliminary plan of the anticipated legal and operating structures ‘consistent with resolution planning and prudential standards’ by the same January date. However, much is still in the air as the CP only sets out the PRA’s initial thinking on financial separation, transparency and disclosure. Final rules are not due until 2016. We should also be mindful that new EU legislation will amend the PRA’s proposals in due course! The latest feedback from Brussels suggests the EU TBTF reforms will not require retail banks to ring-fence their core operations. There will be a ban on proprietary trading for systemically important banks (although trading in EU sovereign debt is permitted) and the threat of the legal and operational separation of certain trading activities, including market-making, from the deposit-taking entity if certain metrics are breached. These regulations will also apply to subsidiaries of non-EU banks.

Surprisingly, the overall wisdom of ring-fencing in the UK is rarely challenged although politicians and economists across the globe have been looking elsewhere in tackling the TBTF issue. The Brisbane G20 recently supported the Financial Stability Board’s proposals for globally important banks to hold additional loss absorbing capacity to help protect taxpayers if these banks fail. Stress-testing has highlighted the need for increased capital but although 25 European banks failed the recent ECA/ECB stress tests, none of these were British. Although the ICB did not see the US ‘Volker rule’ as a substitute for ring-fencing, Paul Volcker himself sees ring-fencing coming unstuck at times of real economic pressure. How can two parts of a bank be entirely independent if subordinated to a holding company especially at a time of crisis?

The ICB was set up to advise the UK government on how to improve financial security without damaging the banking industry or the national economy. However, the Chancellor has estimated the cost of ring-fencing to UK banks at between £3.5bn and £8bn! This is money well spent only if there is no future banking crisis but, more fundamentally, did the ICB mis-diagnose the problem? Northern Rock and the Bradford & Bingley were retail operations and not Lehman Brothers. UK banks collapsed as a result of poor decisions by bankers aided and abetted by a Government economic policy based on credit. The role played by Bank of England in the financial crisis has never been satisfactorily explained. In the case of Northern Rock, how could they have been permitted to fund long term mortgages through money market activities? Surely supervisors were well aware of the commercial exposure of RBS and HBOS? The latest UK banking reforms focus on elaborate corporate structures and yet more regulation with no certainty of success. This does appear to be a case of fitting a bigger horn rather than curing defective brakes. More could be achieved at far less cost by adopting stricter prudential requirements, including stringent leverage ratios, in order to create smaller, non-systemically important banks. Even more elementary, legislation should commit banks to always acting in the best interests of their customers with imprisonment for executive offenders and permitting no ‘collective’ defence.

The face of investment banking is already changing as new capital requirements have bitten hard (eg Barclays and RBS), and world regulators are now rightly focusing on the shadow banking sector. Undoubtedly, to reduce the risk of another calamitous financial crisis, we need common global standards in banking to deliver a level playing field and avoid regulatory arbitrage. Whilst well intended, the UK ring-fence will severely disadvantage its home banking industry in what are fundamentally international markets. Overall, the case today for ring-fencing UK banks is a weak one. Its gestation bears all the hallmarks of rushed legislation. Sadly, with a General Election next May, we can expect no change in UK government policy. Vote winning anti-bank sentiment has clouded sound judgement and in applying a mis-guided concept many may yet rue the day when expediency over-ruled common sense.


ECB stays put but warns about surge in infections



ECB stays put but warns about surge in infections 1

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) – The European Central Bank warned on Thursday that a new surge in COVID-19 infections poses risks to the euro zone’s recovery and reaffirmed its pledge to keep borrowing costs low to help the economy through the pandemic.

Having extended stimulus well into next year with a massive support package in December, ECB policymakers kept policy unchanged on Thursday, keen to let governments take over the task of keeping the euro zone economy afloat until normal business activity can resume.

But they warned about a new rise in infections and the ensuing restrictions to economic activity, saying they were prepared to provide even more support to the economy if needed.

“The renewed surge in coronavirus (COVID-19) infections and the restrictive and prolonged containment measures imposed in many euro area countries are disrupting economic activity,” ECB President Christine Lagarde said in her opening statement.

Fresh lockdowns, a slow start to vaccinations across the 19 countries that use the euro, and the currency’s strength will increase headwinds for exporters, challenging the ECB’s forecasts of a robust recovery starting in the second quarter.

Lagarde saluted the start of vaccinations as “an important milestone” despite “some difficulty” and said the latest data was still in line with the ECB’s forecasts.

She conceded that the strong euro, which hit a 2-1/2 year high against the dollar earlier this month, was putting a dampener on inflation and reaffirmed that the ECB would continue to monitor the exchange rate.

The euro has dropped 1% on a trade-weighted basis since the start of the year, but is up nearly 7% over the last 12 months. Against the U.S. dollar, that number rises to over 10%.


Opening the door for more stimulus if needed, Lagarde confirmed the ECB would continue buying bonds until “it judges that the coronavirus crisis phase is over”.

Lagarde also kept a closely watched reference to “downside” risks facing the euro zone economy, which has been a reliable indicator that the ECB saw policy easing as more likely than tightening.

But she signalled those risks were less acute, in part thanks to the recent Brexit deal.

“The news about the prospects for the global economy, the agreement on future EU-UK relations and the start of vaccination campaigns is encouraging,” Lagarde said. “But the ongoing pandemic and its implications for economic and financial conditions continue to be sources of downside risk.”

Lagarde conceded that the immediate future was challenging but argued that should not impact the longer term.

“Once the impact of the pandemic fades, a recovery in demand, supported by accommodative fiscal and monetary policies, will put upward pressure on inflation over the medium term,” Lagarde said.

Benign market indicators support Lagarde’s argument. Stocks are rising, interest rates are steady and government borrowing costs are trending lower, despite some political drama in Italy.

There is also around 1 trillion euros of untapped funds in the Pandemic Emergency Purchase Programme (PEPP) to back up her pledge to keep borrowing costs at record lows.

The ECB has indicated it may not even need it to use it all.

“If favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full,” Lagarde said.

Recent economic history also favours the ECB. When most of the economy reopened last summer, activity rebounded more quickly than expected, indicating that firms were more resilient than had been feared.

Uncomfortably low inflation is set to remain a thorn in the ECB’s side for years to come, however, even if surging oil demand helps put upward pressure on prices in 2021.

With Thursday’s decision, the ECB’s benchmark deposit rate remained at minus 0.5% while the overall quota for bond purchases under PEPP was maintained at 1.85 trillion euros.

(Editing by Catherine Evans)

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Bank of Japan lifts next year’s growth forecast, saves ammunition as virus risks linger



Bank of Japan lifts next year's growth forecast, saves ammunition as virus risks linger 2

By Leika Kihara and Tetsushi Kajimoto

TOKYO (Reuters) – The Bank of Japan kept monetary policy steady on Thursday and upgraded its economic forecast for next fiscal year, but warned of escalating risks to the outlook as new coronavirus emergency measures threatened to derail a fragile recovery.

BOJ Governor Haruhiko Kuroda said the board also discussed the bank’s review of its policy tools due in March, though dropped few hints on what the outcome could be.

“Our review won’t focus just on addressing the side-effects of our policy. We need to make it more effective and agile,” Kuroda told a news conference.

As widely expected, the BOJ maintained its targets under yield curve control (YCC) at -0.1% for short-term interest rates and around 0% for 10-year bond yields.

In fresh quarterly projections, the BOJ upgraded next fiscal year’s growth forecast to a 3.9% expansion from a 3.6% gain seen three months ago based on hopes the government’s huge spending package will soften the blow from the pandemic.

But it offered a bleaker view on consumption, warning that services spending will remain under “strong downward pressure” due to fresh state of emergency measures taken this month.

“Japan’s economy is picking up as a trend,” the BOJ said in the report, offering a slightly more nuanced view than last month when it said growth was “picking up.”

While Kuroda reiterated the BOJ’s readiness to ramp up stimulus further, he voiced hope robust exports and expected roll-outs of vaccines will brighten prospects for a recovery.

“I don’t think the risk of Japan sliding back into deflation is high,” he said, signalling the BOJ has offered sufficient stimulus for now to ease the blow from COVID-19.


Many analysts had expected the BOJ to hold fire ahead of a policy review in March, which aims to make its tools sustainable as Japan braces for a prolonged battle with COVID-19.

Sources have told Reuters the BOJ will discuss ways to scale back its massive purchases of exchange-traded funds (ETF) and loosen its grip on YCC to breathe life back into markets numbed by years of heavy-handed intervention.

Kuroda said the BOJ may look at such options at the review, but stressed a decision will depend on the findings of its scrutiny into the effects and costs of YCC.

He also made clear any steps the BOJ would take will not lead to a withdrawal of stimulus.

“It’s too early to exit from our massive monetary easing programme at this point,” Kuroda said. “Western economies have been deploying monetary easing steps for a decade, and none of them are mulling an exit now.”

(Reporting by Leika Kihara and Tetsushi Kajimoto; additional reporting by Kaori Kaneko; Editing by Simon Cameron-Moore & Shri Navaratnam)

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World Bank, IMF agree to hold April meetings online due to COVID-19 risks



World Bank, IMF agree to hold April meetings online due to COVID-19 risks 3

WASHINGTON (Reuters) – The International Monetary Fund and the World Bank have agreed to hold their spring meetings, planned for April 5-11, online instead of in person due to continued concerns about the coronavirus pandemic, they said in joint statement.

The meetings usually bring some 10,000 government officials, journalists, business people and civil society representatives from across the world to a tightly-packed two-block area of Washington that houses their headquarters.

This will be the third of the institutions’ semiannual meetings to be held virtually due to the pandemic.

(Reporting by Andrea Shalal; Editing by Chris Rees

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