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How high is your ring-fence?

One of the intriguing notions in the run up to the Vickers report publication has been the “height” of the ring-fence. And indeed, what that even means.  Well now we know.

The ICB’s test for deciding the height of the fence is that a ring-fenced bank is “not dependent for its solvency, liquidity or continued operations on the rest of the group”.  Full separation – the ultimate ring-fence - would certainly achieve that and Vickers considered contagion arguments for full separation. But the ICB concluded that “more retail banks would fail under full separation than under ring-fencing” so has rejected that notion.

But although full separation is not required, a ring-fenced bank must still be able to operate even if its parent or other members of its group fail.  That means it either has to own its own infrastructure, or if it shares infrastructure, it must be housed in a subsidiary of the group which is “bankruptcy-remote”. The essence is that the ring-fenced unit must have continuous access to all necessary operations, staff, data and services.

There’s a long list of such infrastructure: payments, treasury, liquidity, risk, finance, technology, HR, premises... Banks vary in how they organise these functions and some are already moving towards shared services models.  The ICB’s recommendations will require banks either to split these functions down the middle, so the ring-fenced bank can own its own version of each – or banks will have to create well-capitalised, bankruptcy-remote shared service subsidiaries to operate these functions on behalf of their retail and wholesale units. And of course they could outsource some functions altogether.

Either way, it means significant operating model change. In line with the Basel III date the report announces a 2019 deadline, but Vickers also strongly urges banks to “implement any operational changes as soon as possible”. It would make sense for banks to consider their preferred future operating model soon-ish, so they can set a clear direction. Then unrelated investment initiatives can be steered to move the bank towards that target model gradually, minimising incremental cost.

Will banks heed this advice – or, a more expensive option in the long run - sit on the fence? What do you think?

 

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