UK Credit

Archegos is a wake-up call for UK banking ringfencing review



It does not seem auspicious – if you are a UK bank.

Just as a panel of big names prepare to launch their review of a UK regulatory response to the financial crisis, comes a multibillion dollar snafu around the world from the World Bank to provide context for the discussion.

The regulatory trap in question is the cantonment, put in place against the industry’s vehement opposition in 2013 to separate the deposit-taking activities of UK retail banks from all the racy attempts taking place in the banking world. investment.

And the snafu is, of course, Archegos Capital Management, in which banks led by Credit Suisse and Nomura, and joined last week by Morgan Stanley, racked up huge losses due to seemingly oversized and poorly managed exposures at the family office. in their prime brokerage. divisions.

The review – which is due to start in earnest this week – is expected to last a year. A multibillion-dollar stain on the global banking sector’s risk management record, however, only adds to the sense in the industry that cantonment is here to stay.

One of the reasons is that the Treasury review is a legislative requirement, rather than motivated by a particular desire for change. Ringfencing has a strong and committed group of advocates, who support both the principle of separating UK retail from investment and international banking and details such as the $ 25 billion deposit threshold. pounds sterling above which separation is a requirement.

Another reason is that the policy has not really been tested. Critics of Ringfencing argue that it is conceptually flawed: Universal and diversified banks are stronger than narrow, focused banks, and the logic of separation only holds if a government, in reality, lets operations fail outside of it. ringfence. John Thanassoulis of Warwick Business School is uncertain: he is investigating whether these lip-service UK banks are really seen as less risky in the eyes of counterparties.

But the fence was designed to give the UK government options in a crisis, beyond just bailing out a wholesale bank. It has not yet been tested under fire. And the mysterious ability of the world’s investment banks to lose huge sums of money on a client, in a way that logically shouldn’t be possible, doesn’t inspire confidence to do without it. “We don’t want large-scale retail banks to be exposed to this type of risk,” one person noted.

One potential change would be the £ 25 billion threshold, given that Goldman Sachs’ Marcus ran into the limit and the launch of a JPMorgan Chase retail product later this year. The cap is, in all fairness, a pretty arbitrary number. The speed at which Goldman peaked and had to pull out of growth suggests a lack of competition for domestic funds, meaning savers are getting a gross deal.

Allowing more retail deposits to fund investment banking activities would require careful justification. But a cap that has a clearer logic behind it, and that can change with the market over time, would be a useful outcome.

There are also valid questions about how ringfencing has worked in practice. The improvement in the concentration and governance of the British units was an advantage. But some argue that “tricked” retail deposits have contributed to a price war that has driven mortgage spreads down dramatically since 2010, forcing smaller competitors out of the market.

Cheap mortgages seem unlikely to be the death of ringfencing – especially as Bank of England research suggests ringfencing may have been a tenth of the fall in spreads.

But it should be noted that the flexibility of the rules designed to prevent deposits from being left out of lending opportunities has not been well used. For reasons of cost or operational simplicity, most ring-fenced banks have remained relatively ‘pure’ even though activities such as lending to large companies, trade finance and simple hedging or derivatives could be found on both sides. on the other side of the ditch.

Even some ringfencing evangelists admit that there could be a change here that does not violate the fundamental principle of separation. Reforming rather than repealing it seems the best result for banks – but it would help if their peers stopped losing huge amounts of money in supposedly simple industries.

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