The UK government, which has endorsed the idea of ring-fencing retail, deposit-taking banking functions from activities such as trading and investment banking, says high net worth individuals will not be forced to put their money into such protected bank segments.

Proposals, contained in a white paper, also raised questions about what happens to Swiss banks, as their country of origin is outside the European Economic Area. The EEA status is important because, to avoid issues with cross-border banks, the UK government proposes that ring-fenced banks should not carry out any banking activities through non-EEA subsidiaries or branches.

Last week, finance minister George Osborne said the government will introduce legislation as soon as possible to push ahead with the ring-fencing idea, designed to ward off the risk of future massive taxpayer bailouts of banks.

A consultation on the white paper runs until 6 September.

At a time when investors are fearful about the economic plight of countries such as Spain and Greece, the document spelled out how much money has, since 2008, been spent on bailing out stricken banks. Across Europe, taxpayers have paid €288 billion (around $363.9 billion) in bank recapitalisations between October 2008 and December 2010. They are still being called upon to provide support, such as recent injections into the Franco-Belgian bank Dexia and Spanish bank Bankia.

The UK is far from alone in overhauling bank regulation. In the US, the so-called “Volcker rule” (named after former Fed chairman Paul Volcker, who proposed the idea) is designed to split trading activity from banking.

One challenge for policymakers has been to reform banks so that these often huge organisations do not overwhelm the ability of governments to rescue ordinary depositors from a collapse. The reforms are also designed to prevent bank failures leading to systemic crises. Some critics of the ring-fencing idea say that many of the most significant problems, however, did not originate with supposedly more risky functions such as investment banks, but in regular, mortgage-lending institutions such as the UK’s Northern Rock.

Setting boundaries

The ring-fencing idea was proposed last September by the Independent Commission on Banking, a government-appointed panel of experts. Ring-fenced banks must hold more loss-absorbing debt – 17 per cent of risk-weighted assets, the white paper proposes. Overseas operations will be exempt if resolvable without risk to UK taxpayers. However, additional loss absorbing capacity may be required of firms if resolvability concerns persist.

There have been concerns as to exactly how large, integrated banking groups with a mix of retail, private banking and other functions will be affected by this legislation. At recent conferences, this publication was told that the impact is not expected to be significant.

High net worth

In a potentially significant section of the 86-page paper, it said that wealthy individuals should not be forced to put money into ring-fenced banks. “Assessing an individual’s total free and investable assets is difficult for banks to do in practice, and harder to enforce. The government therefore does not support using an assessment of a customer’s total free and investable assets,” it said.

“The government believes that an appropriate threshold for exemption is between £250,000 and £750,000 of free and investable assets with a single bank. This threshold would exempt between 0.2 per cent and 0.1 per cent of the population, respectively. Banks use slightly different definitions of free and investable assets. The government will consider further what definition of free and investable assets should apply in this context,” the document continued.

Given other difficulties in defining what counts as an appropriate asset, the white paper said the approach in how people are regarded as “professional investors” under the MiFid directive should be instituted to ensure that individuals only have their deposits placed outside the ring-fenced entity should they actively choose to do so.

“It would not be desirable for an individual to have their deposits transferred immediately from a non-ring-fenced to a ring-fenced bank where their level of free and investable assets temporarily dipped below the threshold required to qualify for an exemption. The government therefore proposes that an individual’s average free and investable assets over a given period be used as a basis for continued compliance with the qualifying criteria for exemption.”

Swiss in the cold?

The white paper said to avoid issues with cross-border banks, it proposed that ring-fenced banks should not carry out any banking activities through non-European Economic Area subsidiaries or branches. Notably, Switzerland is not a member of the EEA.

WealthBriefing has been told that this issue is a potential headache for two of the biggest wealth management firms in the industry: UBS and Credit Suisse, although the fine details of the reforms may not have a significant effect in practice.

The report said that where a ring-fenced bank operates in a wider group, non-EEA operations will have to be undertaken in separate subsidiaries of the group.

“The presence of overseas subsidiaries and branches within financial groups can significantly complicate the resolution of firms due to the difficulties in establishing claims in multiple jurisdictions and coordinating multiple resolution authorities,” the white paper said.