The cost of making UK banking safer

The Icesave website seen in October 2008 The new Bank of England rules are designed to prevent losses like those experienced by Icesave customers

To avoid another Icesave and taxpayer bank rescue, the Bank of England (BoE) is proposing new rules that negatively affect competition. The estimated effect is marginal but it's coming at a time when the UK needs more business lending in particular.

Since the financial crash, there have been two main goals in Britain's banking sector - to make banks safer, and to increase lending, partly by increasing the number of banks offering loans. So, is there a trade-off?

This debate is evident in a set of proposals from the Bank of England as to how to regulate foreign banks. It's not the entire answer, but these regulations are geared at avoiding a repeat of the Icelandic disaster in the last banking crisis.

If the branch of a foreign bank goes bust, who pays? Right now, it's basically the UK taxpayer. This is what happened when Icesave collapsed in 2008. British depositors were protected, but because Iceland didn't pay up fully, UK taxpayers were left £100m out of pocket.

Why? Well, the UK's deposit guarantee scheme covers up to £85,000 and applies to UK branches of banks, including banks based outside of Europe. But if that money isn't recouped through the bankruptcy process, then it's a loss to the UK financial system as a whole.

So, to make the banking system safer, the Bank of England wants to change the rules for new entrants, which would also affect 145 non-European banks with branches in the UK, of which 82 offer retail and wholesale banking services. Those branches account for nearly one third, or £2.4tn, of UK banking assets, which is equal to a staggering 160% of GDP (this raises another question about whether that's really the bigger problem - an out-sized banking sector in an economy where there isn't enough lending).

To meet the new safety criteria, the Bank of England's proposed regulations mean banks outside Europe (countries in the European Economic Area) may need to operate as subsidiaries that would be governed by the UK Prudential Regulatory Authority (PRA), and not operate as branches (that are governed by their home country's banking regulations). Subsidiaries, unlike branches, are usually separately capitalised, meaning they hold more capital within the country's borders and are considered safer as a result. Right now, there are far more branches (31% of banking assets) than foreign subsidiaries (14%) in the UK.

It may be a sensible move, but it's not cheap. For a branch with assets of less than £2bn to convert to a subsidiary, the PRA estimates there will be an one-off cost of £525,000 and annual costs of £150,000. There are also other indirect costs the PRA can't quantify, such as having to hold more capital in a UK subsidiary, which is a separate legal entity from the parent bank, unlike a branch.

The PRA estimates there might be a "marginal impact" on competition. In the important retail banking sector, the regulator says the costs of becoming a subsidiary may be too high and lead some firms to leave Britain. It could also increase the cost for any bank thinking about setting up shop to offer retail banking. The PRA doesn't expect much of an impact on wholesale banking, although it can't rule out some "minor" effects on competition. The end result is that it could deter some international banks from setting up in the UK.

In an exclusive interview Andrew Bailey, deputy governor for prudential regulation at the Bank of England and PRA chief executive, agreed the plans could deter some banks, but said he didn't want foreign branches to be how competition returns to retail banking. In other words, subsidiaries are more expensive to operate but would be safer.

It's not only bankruptcy and taxpayers left holding the bill that regulators are worried about. A recent Bank of England research paper points to foreign branches as more volatile in terms of lending than subsidiaries. They end up worsening a downturn because they cut back on lending far more than subsidiaries that behave more like UK banks - though they weren't lending much either.

In the last boom and bust cycle, lending growth by foreign branches to UK households and firms reached a peak of 23% in the third quarter of 2007 and fell by the same amount in the third quarter of 2009. In other words, their lending grew by a quarter and fell by a quarter, which is fairly dramatic. UK banks and subsidiaries of foreign banks were not nearly so volatile. The Bank of England research found it made the credit crunch worse, since foreign branches had accounted for one fifth of all lending before the crisis.

Foreign branches accounted for almost half of all banking assets in 2007, so they are particularly important in Britain. It's down to about 30% as of 2012, but that is still twice as important compared to any other country - the closest are Belgium and Luxembourg, where branch assets account for about 15% of banking assets.

But, for those foreign banks that don't take retail deposits so the taxpayer isn't on the hook, these proposed regulations could make it easier to operate as branches. If they meet the newly specified criteria, including a key one of who pays for resolution in the case of collapse, then becoming branches which are cheaper to operate would bolster London as an international financial centre. Mr Bailey mentioned that Chinese banks in particular could find it clearer as to how they operate as branches. This would support one of the government's aims of making London an offshore hub for the RMB, the Chinese currency.

The PRA comes down on the side of safety and says that even though the costs to set up in Britain will increase and slightly hurt competition, it's a price worth paying to have a sound banking system.

So, there may be several reasons to want to change the banking system and make it safer. Andrew Bailey says the government supports the principle of these proposals. It may, though, go against the government's push to attract more banks to the UK.

After the crisis, the UK retail banking sector shrank considerably and is down to just a handful of large banks. The government has been trying to boost competition in the banking sector, but with limited success. Business Secretary Vince Cable has pointed to the problem being not so much in mortgage, but business lending. In a speech last month, he said: "In mortgage lending we have plenty of competition, the real problem is business lending — they are terribly dependent on a handful of institutions, most of which are contracting their lending."

Even though these proposals may only marginally affect competition in banking, that task may just be that much harder.

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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  • rate this

    Comment number 34.

    31.S S Everyone is being sacrificed to save the banks - average earnings in real terms are now back to 2002 levels, savers are being actively discouraged and there can be no end to the squeeze. The ship will not turn up (Dickens) it is not the case one in one bound we are free. All are lies.

    The ONLY end (solution) is to treat the banks as bankrupt for that is what they are. We must deleverage!

  • rate this

    Comment number 33.


    == Oh.....really, when China had their banking system over a thousand years ago, we 'British' did not even know what the toilet paper was about

    Its NOT about who was 1st, it is about present day realitys.

    Please present Chinese banks assets/lending & financial information.

    Oh, its SECRET, not transparent, unreliable.

    Your point is not even 1% relevent

  • rate this

    Comment number 32.

    You can see an aversion to risk as negative or, if you are rational and logical, you can see it as positive. Coming from the dour and austere yet rational and logical part of our cultural spectrum I am all in favour of reducing risk.

    I appreciate risk is exciting and huge profits can accrue as a consequence but I would rather put a few quid aside each day than bet everything on a rat-race.

  • rate this

    Comment number 31.

    Savers are still the sacrificial lamb that has paid the price for all the banks misdemeanours, such as mis-selling PPI, fines for money laundering & LIBOR fixing
    … and propping up the housing market

    The Gov set up a safeguard of £85k in case of banks going into administration --- but the rest still stinks

    It’s like shooting fish in a barrel!!

  • rate this

    Comment number 30.

    What Iceland did (kill bust banks) is the ONLY way to provide the right conditions for the economy to recover. We haven't done so - so our economy will NEVER have a chance to recover.

    That is the lesson of economic history after every previous recoded bubble/crash throughout time (or at least back to mid Victorian times where the data is available)

    We must deleverage. There isn't a choice.

  • rate this

    Comment number 29.

    So Iceland didn't pay up... and is Iceland still allowed access to the UK banking system. Ummm..yes it is...

    Iceland is largely paying up albeit on its own timescale,
    About 86p to 90p in the £ from Heritable
    Kaupthing 81p to 86p in £
    All of the lost funds from Glitnir & Landsbanki

  • rate this

    Comment number 28.

    if there are claims on insurance the premiums go up, that's kinda what's happening here. They never thought they'd be major payouts from the guarantee scheme, but there was a pretty large one so in future it's going to cost more to be in the scheme

    no they were market leading rates for that type of investment but not so far out as to be unduly suspicous given the overall spread of rates

  • rate this

    Comment number 27.

    Corporate greed is a symptom of the rise in entitlement and rights at the expense of responsibility. It reflects the fragmentation of a society and the breakdown of cohesion. It comes when notions of morality and historic values are traduced and scorned for their very tradition.

    You cannot legislate for greed and cannot outlaw avarice. The only solution is a comprehensive cultural change.

  • rate this

    Comment number 26.

    A failed banker gets a £935,000 bonus but millions of hardworking people on minimum wage get a 19p an hour pay rise.
    All this from a government that claims to be the workers party.

  • rate this

    Comment number 25.

    Nice article Linda, but once again, like all financial and political writers, too many words,strung together to make sentences that really have no bearing on what will actually happen. Seems like an exercise in futility trying to make any meaningful legislation. View the coming state of play with RBS. Who put the jokers at the top in charge. Not the taxpayer.
    No one ever seems accountable.

  • rate this

    Comment number 24.

    The cost? How much does it cost to print a few P 45s and to run up a few Charge Sheets.

  • rate this

    Comment number 23.

    So all we need is more regulations and then everything wll be fine? Have you not seen the encyclopaedic amounts of regulation that already exist? Take out an new credit card, see all the terms and conditions A new mortgage comes with a book of regulations. Bank regulations are BOGUS! Allowing bankruptcy, allowing banks to fail, is the ONLY real "regulation" that has teeth!

  • rate this

    Comment number 22.

    17.Truth logic sustainability the final frontiers

    China banking system is primitive

    == Oh.....really, when China had their banking system over a thousand years ago, we 'British' did not even know what the toilet paper was about

  • rate this

    Comment number 21.

    If there is stress testing on assets that are considered frothy, even if not in bubble territory, and procedures put in place to increase the cost of frothy assets (for example for mortgages: post code caps on the maximum LTVs, limits on multiples of earnings to mortgage value, etc.) then asset values can be controlled without using blunt interest rate changes to control the market.

  • rate this

    Comment number 20.

    Icesave was a cock-up.
    Their interest rates were much higher than those available from UK banks.
    It was obvious to prudent savers that their offer was "too good to be true."
    But those who acted imprudently, and enjoyed high interest rates, were bailed out by the British taxpayer when it went belly up.
    Compare that to Farepak and Equitable Life.
    I agree, we need to take a harder line.

  • rate this

    Comment number 19.

    For those of you who hate my analysis may I recommend that you read other's who share my view.. such as Ha-Joon Chang

    Get used to it we are I regret to say correct.

    QE (& zero Rates) is and always was an economic dead end. It just amplifies the destruction.

  • rate this

    Comment number 18.

    15-17 TLSTFF "where has the value come from"

    QE (and zero rates and banking regulators force feeding the bankers with cash.)

    The ONLY way is POP! (sound of a bubble bursting).

    Lets have a new term "Insanonomics" (v Abenomics)

    Defined as economics of the mad house - a known and historically well documented way to collapse the global economy and destroy jobs.

    I'll think about writing a wiki!

  • rate this

    Comment number 17.

    Nothing UK government imposes via regulations can prevent a same/similar crisis repeating because UK government does not control banking in other countrys.

    UK cannot stop another Lehman Brothers, in USA, Switzerland or China.

    China banking system is primitive, non transparant & much is corrupt, yet some would have us believe all is manageable.

    Talk about Déjà vu !!!

  • rate this

    Comment number 16.

    UK banking cannot be safer, it may be more restrictive, but it will not be safer.

    Majority of lending is based upon asset values. UK housing is still over inflated & a London bubble is growing.

    Also stocks/shares, lol, have already risen past 2008 values, yet economies are NOT producing anywhere near production of 2008, so where has the value come from - BUBBLE

    Asset crash = BANK crash

  • rate this

    Comment number 15.

    It is all pointless, & deceitful.

    While UK banks bought into high risk mortgages in UK they managed them, & a % of yearly losses relative to risks, just as they manage £$millions of fraud losses each year.

    The biggest threat to UK banking is not from within but a repeat of banking crisis from abroad, next time namely China, where banking is as transparant as the air the Chinese breathe


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