Ring-fencing retail banking

The Chancellor is expected to force UK banks to ring-fence their retail banking operations from riskier investment banking in his Mansion House speech this evening.

The move would see retail banking, such as savings accounts and mortgages to individuals, protected in the event that their investment trading arms ran into financial difficulty, again.

This is a big change to the way banking is structured in the UK.

It will also see banks having to increase their capital reserves to a level higher than the new international minimum of 7% of their riskier assets.

It has been suggested this new requirement may be introduced at a level of 10%. This would be in line with the Independent Commission on Banking (ICB) interim report recommendations earlier this year.

Ring-fencing retail banking operations from investment banking is potentially good news for banking customers and the taxpayer.

In the event of a future financial crisis, it would be much easier to entirely break away retail banking from investment banking, keeping savers safe.

This structure would also make any future rescue deal much cheaper for the taxpayer. It removes the inherent moral hazard created by the knowledge that the taxpayer would save a floundering investment bank in order to protect savers in the connected retail bank.

Ring-fencing retail banking would not prevent the failure of investment banks, but it would prevent the taxpayer from needing to bail them out in the future.

There is a risk that the move could increase the cost of retail banking for savers and borrowers.

Without the ability to so effectively cross-subsidise the generation of profits from investment banking activity, retail banking will need to become more profitable in its own right.

Whilst retail banking has never really been ‘free’, a move to ring-fence it from investment banking could make the true costs of retail banking more visible.

We also worry it will increase the pressure on bank branch staff to push unsuitable investment products on savers, in order to boost their revenues.

Until we see the full details of the proposal, it is difficult to assess whether this news is good, bad or indifferent for savers and the taxpayer.

Photo credit: Flickr/ell brown