The global financial crisis that began in 2007 led to a number of changes in the structure of the largest banks in the UK. In addition to the introduction of the Senior Managers and Certification Regime, the concept of ring-fencing retail deposits from riskier banking activities, such as investment banking was introduced.
Under the Financial Services (Banking Reform) Act 2013 (FSBRA), since 1st January 2019, the largest UK banks are required to separate core retail banking services from their investment and international banking activities. This applied to all banks with core retail deposits of more than £25 billion.
In addition to providing the statutory footing for the regime, FSBRA also set out a requirement for the government to commission an independent review of the regime within two years of it coming into full effect. This review, undertaken by a panel of independent experts led by Sir Keith Skeoch (the Panel), launched in February 2021 and delivered its final report in March 2022.
Inside the ring-fence
The aim of ring-fencing is to protect the core retail banking services on which customers rely from risks associated with riskier activities outside the ring-fence which include investment banking and wealth management. It is intended to improve the resilience of the largest UK banks. It also seeks to ensure that if a large bank were to fail, there would be minimal disruption to banking services used by individuals and small businesses in the United Kingdom.
The conclusion of the review was that in general, the rules are performing satisfactorily
Retail banking includes essential products like Savings Accounts, Current Accounts, and Debit Cards. Financial assistance products like Credit Card and Loans are included under Retail Banking. Services like personal investment banking and personal wealth management fall under retail banking.
Retail banking will also include savings accounts and other personal financial services. The bank may offer deposit accounts, cash ISAs and other savings products. The bank may offer investment products like personal pensions, stocks & shares ISAs and investment bonds.
Some banks deal only with very wealthy (high net worth) individuals, these are known as private banks, they would still need to be ring-fenced under the FSBRA if they have retail deposits in excess of the threshold and may be outside the revised threshold discussed below.
The provision of credit cards, personal loans and mortgages are also inside the ring-fence.
Outside the ring-fence
Investment banking in this context is the division of a bank or financial institution that serves governments, corporations, and institutions by providing underwriting (capital raising) and mergers and acquisitions (M&A) advisory services. Investment banks act as intermediaries between investors (who have money to invest) and corporations (who require capital to grow and run their businesses).
You can see that investment banking is more risky than retail or personal banking, which is why, after the financial crash, the Bank of England ringfenced retail banking from investment banking. Investment Banks are outside of the ring-fence.
Full-service banks offer the following services:
• Underwriting: capital raising and underwriting groups work between investors and companies that want to raise money or list on a stock exchange via an initial public offering (IPO). This function serves the primary market or “new capital”.
• Mergers & Acquisitions (M&A): advisory roles for both buyers and sellers of businesses, managing the M&A process from start to finish.
• Sales & Trading: matching up buyers and sellers of securities in the secondary market. Sales and trading groups in investment banking act as agents for clients and also can trade the firm’s own capital.
• Equity Research: the equity research group helps investors make investment decisions and supports trading of stocks.
• Asset Management: managing investments for a wide range of investors including both institutions and individuals, across a wide range of investment styles.
The five-year review
In 2023, the PRA commissioned its first five-year review of the ring-fencing rules the results of which were presented to HM Treasury in December 2023 and published in January 2024.
The conclusion of the review was that in general, the rules are performing satisfactorily. There were four areas where the PRA identified potential improvements:
• Rules relating to the provision of services to Ring-Fenced Bodies (RFB) from non-ring-fenced parts of a group. There is potential overlap with other PRA rules relating to securing operational continuity in resolution and the operational resilience of banks. The PRA considers that the rules could be better aligned with existing processes that banks must follow to identify how important business functions depend on resources and services elsewhere in a group, and to focus more directly on the core activities and essential business of RFBs.
• Rules relating to arm’s length transactions. The requirement to transact only on an arm’s length basis remains essential. However, the frequency with which RFBs must review their internal policies underpinning how this is operationalised could be reviewed on grounds of proportionality. They consider there may be potential to reduce this frequency subject to any necessary safeguards.
• Modifications of rules relating to governance arrangements. Rules in this area have been extensively modified to tailor them to the circumstances of individual RFBs. Where further changes are needed, on application from RFBs, they will consider maintaining the modifications for longer periods before the changes expire. In addition, they consider that there may be scope to re-assess the level of consolidation at which some of the governance rules apply with a view to simplifying the requirements on firms.
• Rules relating to regulatory reporting. They have identified one annual regulatory report which they think may be unnecessary given the materiality of the amounts that have been reported since the regime came into effect. This relates to tax exposures for which an RFB may be liable in relation to the business of a non-ring-fenced body (NRFB). Some reports will be in scope of the Banking Data Review.
The Edinburgh Reforms
On 9th December 2022, as part of the Edinburgh Reforms, the government announced its intention to consult on a series of near-term reforms to the ring-fencing regime, broadly taking forward the Panel’s recommendations. The government announced that these reforms would:
• Take banking groups without major investment banking operations out of the regime. This would remove a barrier to growth for smaller banks and support domestic competition.
• Update the definition of a Relevant Financial Institution (RFI) to remove
• barriers that prevent some small businesses from accessing financial services.
• Remove blanket geographical restrictions on ring-fenced banks (RFBs), helping UK banks to compete internationally and supporting UK businesses operating abroad.
• Take forward technical amendments outlined in the Panel’s recommendations to improve the functioning of the regime, removing unintended consequences, and providing benefits for the sector and the economy.
• Review and update the list of activities which RFBs are restricted from carrying out in order to assess whether certain activities could in the future be undertaken safely and improve the supply of financial services to consumers and businesses.
• Increase the deposit threshold – i.e., the point at which ring-fencing applies to banks – from £25 billion deposits to £35 billion deposits. This announcement went beyond the Panel’s recommendations as the government considers that the appropriate deposit level has increased since it was first determined.
These proposals were out to consultation with the Government introducing Secondary Legislation to implement the reforms during 2024.
