Vickers Review / Independent Commission on Banking

The Commission recommends that the Government seek agreement with Lloyds to ensure that the divestiture leads to the emergence of a strong challenger bank.

The Commission recommends the early introduction of a redirection service for personal and SME current accounts which, among other things, transfers accounts within seven working days, provides seamless redirection for more than a year, and is free of risk and cost to customers. This should boost confidence in the ease of switching and enhance the competitive pressure exerted on banks through customer choice.

Transparency should be improved by requirements on banks to disclose more information about prices, including by displaying interest foregone on annual current account statements, and through the sector regulator acting to make current accounts more easily comparable.

The Commission recommends that the statement of objectives for the FCA is strengthened accordingly [to secure the policy goal of a pro-competitive FCA more effectively than in the current proposed wording of the duties of the FCA].

A market investigation reference should be actively considered if one or more of the following conditions is not achieved by 2015: a strong and effective challenger has resulted from the Lloyds divestiture; ease of switching has been transformed by the early establishment of a robust and risk-free redirection service together with much greater transparency; and a strongly pro-competitive FCA has been established and is demonstrating progress to improve transparency and reduce barriers to entry and growth by rivals to incumbent banks. If the OFT has not already made one following its proposed review in 2012 of the personal current account market, a market investigation reference should be actively considered.

Large UK retail banks should have equity capital of at least 10% of risk-weighted assets. This exceeds the Basel III minimum, even for G-SIBs, and the backstop leverage cap should be tightened correspondingly. International standards can apply to the activities of UK banks outside their UK retail subsidiaries so long as they have credible resolution plans including adequate loss-absorbing debt.

The Commission's recommendation is that large ring-fenced banks should be required to have an equity 'ring-fence buffer' of at least 3% of RWAs above the Basel III baseline of 7% of RWAs. (A ring-fenced bank is defined to be 'large' if its RWAs-to-UK GDP ratio is 3% or above.) Smaller ring-fenced banks should have correspondingly smaller ring-fenced buffers.

Regulators should be given the discretion to impose a 'resolution buffer', which may require banks to have up to 3% of RWAs of additional equity (or other loss-absorbing capacity) if they are not readily resolvable.

A sliding scale should be used to build up the size of the ring-fence buffer from zero to 3% of RWAs (for large ring-fenced banks). A simple method for calibrating the size of this buffer for smaller banks would be to set it to zero for banks with a RWAs-to-UK GDP ratio of 1% or less, and increase the size of the buffer linearly with banks' RWAs-to-UK GDP ratio so that it reaches 3% for banks with a RWAs-to-UK GDP ratio of 3%.

The retail and other activities of large UK banking groups should both have primary loss-absorbing capacity of at least 17%-20%. Equity and other capital would be part of that (or all if a bank so wished). Primary loss-absorbing capacity also includes long-term unsecured debt that regulators could require to bear losses in resolution (bail-in bonds). If market participants chose, and regulators were satisfied that the instruments were appropriate, primary loss-absorbing capacity could also include contingent capital ('cocos') that (like equity) takes losses before resolution.

The authorities should take bail-in powers which allow them to impose losses on 'bail-in bonds' – long-term unsecured debt available to absorb losses in resolution – and other unsecured liabilities. If primary loss-absorbing capacity is wiped out, regulators should also have the power to impose losses on other creditors in resolution, if necessary.

The Commission also recommends depositor preference for deposits insured by the FSCS. Those deposits – and hence the FSCS (and, in the last resort, the public purse) – would then rank higher than other unsecured debt if it came to insolvency. This prospect would reinforce the credibility of such debt bearing loss in resolution, as would the subordination (as a result of bail-in) of long-term unsecured debt to non-preferred depositors in resolution.

The ring-fence buffer should also extend the CCB. The rationale for the ring-fence buffer overlaps to some extent with the rationale for the G-SIB surcharge, i.e. requiring larger banks to have more equity to reflect the greater social costs of their failure. So the two should not be additive. Instead, if a bank is subject to both a ring-fence buffer and a G-SIB surcharge, it is only the higher of the two that should be applied.

Mandated services. Only ring-fenced banks should be granted permission by the UK regulator to provide mandated services. Mandated services should be those banking services where: a) even a temporary interruption to the provision of service resulting from the failure of a bank has significant economic costs; and b) customers are not well equipped to plan for such an interruption. Mandated services currently comprise the taking of deposits from, and the provision of overdrafts to, individuals and small and medium-sized organisations.

Prohibited services. Ring-fenced banks should be prohibited from providing certain services. Prohibited services should be those banking services which meet any of the following criteria: a) make it significantly harder and/or more costly to resolve the ring-fenced bank; b) directly increase the exposure of the ring-fenced bank to global financial markets; c) involve the ring-fenced bank taking risk and are not integral to the provision of payments services to customers, or the direct intermediation of funds between savers and borrowers within the non-financial sector; or d) in any other way threaten the objectives of the ring-fence. As a result prohibited services should include (though need not be limited to): a) any service which is not provided to customers within the EEA; b) any service which results in an exposure to a non-ring-fenced bank or a non-bank financial organisation, except those associated with the provision of payments services where the regulator has deemed this appropriate; c) any service which would result in a trading book asset; d) any service which would result in a requirement to hold regulatory capital against market risk; e) the purchase or origination of derivatives or other contracts which would result in a requirement to hold regulatory capital against counterparty credit risk; and f) services relating to secondary markets activity including the purchase of loans or securities.

Ancillary activities. The only activities which a ring-fenced bank should be permitted to engage in are: the provision of services which are not prohibited; and those ancillary activities necessary for the efficient provision of such services. Ancillary activities should be permitted only to the extent they are required for this provision, and not as standalone lines of business. Ancillary activities would include, for example, employing staff and owning or procuring the necessary operational infrastructure. In particular, a ring-fenced bank should be permitted to conduct financial activities beyond the provision of non-prohibited services to the extent that these are strictly required for the purposes of its treasury function – i.e. for risk management, liquidity management, or in order to raise funding for the provision of non-prohibited services. In conducting ancillary activities a ring-fenced bank may transact with and become exposed to non-ring-fenced banks and non-bank financial organisations. Backstop limits should be placed on the proportion of a ring-fenced bank's funding which is permitted to be wholesale funding and on its total exposures, secured and unsecured, to non-ring-fenced banks and other non-bank financial companies.

Legal and operational links. Where a ring-fenced bank is part of a wider corporate group, the authorities should have confidence that they can isolate it from the rest of the group in a matter of days and continue the provision of its services without providing solvency support. As a result: a) ring-fenced banks should be separate legal entities – i.e. any UK regulated legal entity which offers mandated services should only also provide services which are not prohibited and conduct ancillary activities; b) any financial organisation owned or partly owned by a ring-fenced bank should conduct only activities permitted within a ring-fenced bank. This organisation's balance sheet should contain only assets and liabilities arising from these services and activities; c) the wider corporate group should be required to put in place arrangements to ensure that the ring-fenced bank has continuous access to all of the operations, staff, data and services required to continue its activities, irrespective of the financial health of the rest of the group; and d) the ring-fenced bank should either be a direct member of all the payments systems that it uses or should use another ring-fenced bank as an agent.

Economic links. Where a ring-fenced bank is part of a wider corporate group, its relationships with entities in that group should be conducted on a third party basis and it should not be dependent for its solvency or liquidity on the continued financial health of the rest of the corporate group. This should be ensured through both regulation and sufficiently independent governance. Thus, where a ring-fenced bank is part of a wider corporate group: a) its relationships with any entities within the same group which are not ring-fenced banks should be treated for regulatory purposes no more favourably than third party relationships; b) all transactions (including secured lending and asset sales) with other parts of the group should be conducted on a commercial and arm's length basis in line with sound and appropriate risk management practices; c) where third party arm's length relationships are not ensured through the application of existing regulation, additional rules should be considered; d) assets should only be sold to and from the ring-fenced bank and other entities within the group at market value. The ring-fenced bank should not acquire any assets from other entities within the group unless such assets could have resulted from the provision of non-prohibited services; e) the ring-fenced bank should meet regulatory requirements, including those for capital, large exposures, liquidity and funding, on a solo basis; f) dividend payments and other capital transfers should only be made after the board of the ring-fenced bank is satisfied that the ring-fenced bank has sufficient financial resources to do so. In addition, any such payments which would cause the ring-fenced bank to breach any kind of capital requirement, including requirements to hold buffers above minimum requirements, should not be permitted without explicit regulatory approval; g) the board of the ring-fenced bank should be independent. The precise degree of independence appropriate would depend on the proportion of the banking group's assets outside the ring-fenced bank. Except in cases where the vast majority of the group's assets were within the ring-fenced bank, the majority of directors should be independent non-executives of whom: i. one is the Chair; and ii. no more than one sits on the board of the parent or another part of the group; h) a ring-fenced bank should make, on a solo basis, all disclosures which are required by the regulator of the wider corporate group and/or its other relevant substantial subsidiaries, and those which would be required if the ring-fenced bank were independently listed on the London Stock Exchange; and i) the boards of the ring-fenced bank and of its parent company should have a duty to maintain the integrity of the ring-fence, and to ensure the ring-fence principles are followed at all times.