The Regulatory Reform | 2014: Living in the Shadow of Regulation? White Paper

This week sees part four of our Success Series over-regulation white paper, focussing on the regulatory reform: the ring-fencing, the corporate governance, at reigning in risk and the danger of payday loans.

To safeguard their financial stability and make it less likely that they will collapse in the future, large financial institutions need to build up enough high quality capital to cover their own losses and make sure that they are not at risk of insolvency.

As it won’t always be possible to prevent institutions from failing, it is also necessary to have agreed principles and processes in place that will allow for timely and orderly resolution that does not unduly affect national economies. Given that large banks and other financial institutions operate globally, the UK will work with other countries and international organisations to agree an international approach to this issue.

  • The UK Government is taking part in international discussions within the EU, the G20 and the Financial Stability Board about how they can respond more effectively to financial risks in the global economy. Its current proposals for banking reform are based on the Independent Commission on Banking (ICB)’s recommendations, the main points being: Globally coordinated system of macro prudential regulation.
  • No too large to fail: ‘Orderly Resolution’.
  • Global forms of governance.


The Banking Reform Act received Royal Assent in December 2013. It will bring into law structural and cultural changes to the banking system:

  • Banks will be required to put a ring fence in place that protects customer deposits from trading floor activities.
  • The failed tripartite system of macro prudential oversight has been replaced by two new authorities that work under the Bank of England and the Treasury:
  1. The Prudential Regulatory Authority (PRA) will hold banks to account for the way they separate their retail and investment activities. The PRA will have the power to enforce full separation of individual banks.
  2. The Financial Conduct Authority (FCA) will impose higher standards of conduct on the banking industry by introducing a criminal sanction for reckless misconduct that leads to bank failure.
  • Banks will be required to subscribe to the Financial Services Compensation Scheme, to protect depositors in the event any bank enters insolvency.
  • The regulations will give government power to ensure that banks are more able to absorb losses by forcing them to hold more equity capital.
  • There will be caps on payday lending.
  • Regulation will make it easier for customers to switch between current account. Providers with a current account switching service, introduced in September 2013.
  • Reforms will be made to the LIBOR process.


Regulations will be implemented in harmony with other global regulators to ensure regulatory arbitrage is avoided.

  • Ideally, the regulatory response becomes an integral component of the strategy, rather than a standalone initiative.
  • The best approach to complex regulatory demands is to organise them into common themes for implementation, with multiple regulations broken down into specific components so that the common aspects of multiple requirements can be dealt with in a single solution.
  • There will be a focus on individual accountability, corporate governance, competition and long-term financial stability.


Let us now consider the main points of the act:


The proposal: The ICB has, according to its Chairman Sir John Vickers, pushed through reforms that have gone “further than most of the rest of the world”.

Key to these is the introduction of a ring-fence that will separate retail banking from notionally riskier investment banking. On top of this, insured retail depositors will be given preference over other debtors if a bank fails.

The problems: As the US found with the Volcker rule banning proprietary trading, the devil is in the detail. Lawyers and bankers warn that ring-fenced banks’ ability to offer derivatives and trade finance to small corporate customers will be reduced, as will be the banks’ ability to do business with other financial institutions. Small banks could be prevented from accessing funding from ring-fenced banks. Ring-fenced banks would be unable to offer some more sophisticated products, such as structured deposits, to customers but smaller ones will.


The proposal: The proposal for a new “senior persons” regime will bring tougher oversight for individuals, along with a certification regime for a broader range of staff. Senior individuals will be subject to a new criminal offence of reckless mismanagement of a bank. If a bank is found guilty of breaching regulatory rules, the individual in charge will have to prove that it was not their fault.

The problems: The regulator had previously vowed to improve its vetting of senior bank staff but that did not prevent Paul Flowers from becoming the chairman of a major lender, Co-operative Bank. However, experts say the new regime looks considerably more draconian. While the criminal sanction appears unlikely to be used, the burden of proof on the individual in charge is particularly tough. The authorities are anxious to prevent a rerun of the last crisis, when few individuals were held to account.


The proposal: The Government has not gone down the road taken by the US, where the Volcker Rule has banned proprietary trading by banks. But the UK’s Prudential Regulation Authority will prepare a report on proprietary trading soon after the ring-fence comes into effect.

The problems: The Volcker Rule is proving legally very difficult to put into full effect, so the UK can tentatively pat itself on the back for dodging that bullet. But that does not mean the ring-fence will be easy – lawyers are only starting to explore the complexities. There is a broader criticism of countries’ attempts to curb the risks of investment banking: many of the big meltdowns of 2007-09 were caused by notionally less risky areas of retail banking, such as mortgage lending.


The proposal: The Financial Conduct Authority will be under a duty to impose an overall cap on the cost of credit charged by short-term lenders such as payday loan companies. The regulator will have to work out the specifics of how this will be implemented.

The problems: The move was a U-turn by George Osborne, the chancellor, late in the legislative process and came in response to pressure on him to do more about the rising cost of living. The move could lead to pressure for the FCA to regulate a broader range of prices.

Next week: The Solutions

A look at the consequences and challenges for banks minimising business disruption, prioritising investment in resource and training, reduced capitals on return, impact on profitabliigy on a risk-adjusted basis and frameworks for banks to tie regulatory reform to their overall strategy.

Written by Eric Bigham. Founder and owner of Bigham Consulting.

View the 2014: Living in the Shadow of Regulation? White Paper Contents Page

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