Banking Standards Joint Committee Contents

3  Possible approaches to structural separation


30. Structural separation is designed to help create a workable framework for the operation of the reforms described in the previous chapter, as well as to bring wider financial stability benefits. This chapter rehearses the main arguments for and against structural separation and examines different approaches to separation. The approaches vary in where the line is drawn between retail and investment banking and what degree of separation is required between the retail and investment entities. In this chapter, "structural separation" is used as a generic term to describe the range of proposals that require separation in some form between different functions of banks, whether remaining within a bank group or being required to be conducted outside of it.

The case for structural separation

31. Without any form of structural separation, the banking market will include so-called 'universal banks', which combine retail, wholesale and investment banking. The starting point of the case for structural separation is often the view that if universal banks fail—for whatever reason—they are very difficult to resolve without posing a risk to the taxpayer or to financial stability. As the ICB put it:

Universal banks are important providers of a number of critical economic services and so their disorderly failure has very high costs for society. Yet the size and complexity of universal banks made it impossible, in the recent crisis, for governments to maintain these services without providing taxpayer support to the whole financial institution. [...] UK banks are big enough for this to represent a real threat to the public finances.[42]

Andrew Bailey, Managing Director, Prudential Business Unit, FSA, suggested that the imperative to protect certain systemically important functions of banks, such as deposit-taking, forced the authorities to intervene to resolve the whole organisation, including those parts which were not systemically important:

one of the biggest problems we have today with contemplating resolution of major banks is that we have a whole range of activities on the balance sheet of the same legal entity [...] Today, we would have to pursue a resolution approach that was driven by the highest priority within that set of activities, but it would effectively be a common resolution approach, because we would have no effective means of splitting things up.[43]

32. The ICB's final report argued that structural separation would make resolution of banks that get into trouble easier and less costly:

Separation would allow better-targeted policies towards banks in difficulty, and would minimise the need for support from the taxpayer. One of the key benefits of separation is that it would make it easier for the authorities to require creditors of failing retail banks, failing wholesale/investment banks, or both, if necessary, to bear losses, instead of the taxpayer.[44]

This view was echoed by António Horta-Osório, Group Chief Executive of Lloyds Banking Group, who thought that "ring-fencing enhances the credibility of recovery and resolution mechanisms because it provides, ex ante, a separation between retail and investment banking".[45]

33. A second, consequential, benefit associated with structural separation between retail and wholesale banking is that separation reduces the benefits of the implicit guarantee for creditors of wholesale banks. Douglas Flint, Chairman of HSBC, told us of the problem in the recent crisis:

the implicit guarantee certainly encouraged those who funded banks on the wholesale side to believe that they were taking less risk than the unsecured nature of their lending represented, and because they were prepared to lend to a greater extent and on finer terms than they might otherwise [have] done, that fund of cheaper money gave a pool of resource to bankers to make money from.[46]

Martin Taylor suggested that structural separation could help to reduce this problem:

the ring-fence is intended to undermine the extension of the implicit Government guarantee to the whole banking organisation—that is, to allow the investment bank, as has been the case in the past, to raise money on the faith and credit, effectively, of the retail organisation. It is our belief that installing the ring-fence will prevent this from happening. If that is successful—and I believe it would be—you will prevent the investment bank from doing certain kinds of business that it was able to do in the pre-crisis years.[47]

Structural separation is thus intended to counteract any perception among creditors of the investment bank that they would be bailed out in a failure, and thus incentivise those creditors to be more prudent in extending credit. This in turn would make it more costly for investment banks to increase leverage and take excessive risks.

34. Third, structural separation may also have the benefit of preventing the possibility of contagion from investment banking operations to systemically important retail functions. For example, the ICB observed that "with integrated universal banking it may be harder to stop problems spreading from one part of the system to another — for example, from wholesale/investment banking to UK retail banking."[48] Although not all crises will originate on the investment bank side, wholesale market operations do have the potential to create problems which may then spill over. For example, RBS was dependent on wholesale funding to finance its capital markets business, especially after its acquisition of ABN AMRO, an acquisition which, as the Treasury Committee has concluded recently, was a significant factor in the difficulties that RBS encountered.[49]

35. Fourth, some form of structural separation between retail and wholesale banks might be expected to make banks easier to manage. Andy Haldane, Executive Director for Financial Stability, Bank of England, made the point that "The evidence base is not encouraging about whether the biggest banks in the world can indeed manage themselves across the board".[50] He argued that:

Ultimately, one of the by-product benefits of things such as structural measures would be to make the balance sheet somewhat simpler and more homogenous, and therefore somewhat easier for investors to value.[51]

Douglas Flint told us that, in his view:

the real benefit of the ring-fence is that it will aid clarity within institutions and between the industry and the public in terms of better defining the roles of all the individual parts that are today in universal banks, so the separation will actually give greater clarity as to what individual parts of the bank are doing.[52]

36. Fifth, separation could result in higher levels of bank capital across the system. The ICB noted: "Universal banks generally hold less capital relative to assets than if they were separated. While this can provide an economic benefit in good times, it can heighten risk at times of general economic stress, when banking system resilience is most needed."[53] Sir John Vickers also pointed out that structural separation helpfully allowed higher capital requirements to be imposed on UK retail banks, without necessarily imposing the same requirement on investment banking operations, which would be more prone to regulatory arbitrage.[54]

37. Structural separation is also seen as bringing cultural benefits. Paul Volcker told us that his biggest concern about current arrangements was not the risks caused by having different types of banking side by side as such, but "the damage that it does to the culture of the whole institution".[55] He added that "trading operations and impersonal proprietary trading operations are simply different from a continual banking relationship."[56] Michael Cohrs expressed similar views in evidence more recently:

if a bank is allowed to do proprietary trading, or proprietary investments, you will not have a culture that you like, because de facto, you are then competing with the client, and it is a heck of a lot easier to do proprietary work than it is to do client service. The best and the brightest within the institution will gravitate to the proprietary activity and we will end up where we have ended up, which is with bankers who sometimes do not understand right from wrong, or at least a pool of them.

Sir Alan Budd recalled the significantly different retail and investment banking cultures at Barclays in the late 1980s and the challenges he saw in integrating the two.[57] Andy Haldane said that "there was a gradual, but very clear, cross-contamination of cultures from the 1980s onwards".[58] Lloyds Banking Group noted that "investment banking has a different business model and culture as it is done deal by deal; retail and commercial banking is about relationship banking through the cycle".[59]Ana Botín, Chief Executive of Santander UK, told us that she believed that "having different subsidiaries helps to have a different culture".[60]

38. Some witnesses also suggested that the particular development of the universal banking model in the UK had changed the culture in a manner that influenced the way banks were led. Martin Taylor said:

One of the big changes that have taken place in the past 10 years is that these organisations are now—or were until very recently, in the case of Barclays—all run by investment bankers. That is a big change; it was not the case in the 1980s or 1990s. I suppose that was done because boards had so much risk on the table in the investment bank, which they imperfectly understood, that they put someone in place who they knew could manage it, or at least understand what was going on.[61]

This view was echoed by Professor Kay:

In the 1980s, what we saw in Britain was the retail banks taking over most of the other activities in the City, as jobbers, brokers and the like were acquired by retail banks. [...] Then there was the second round, which we have seen in the past 10 to 15 years, which worked the opposite way round, in that it was the investment bankers who took over the entire conglomerates and the retail banking activities were subordinated, essentially, to them. Until Diamond was removed at Barclays, we had essentially reached a position in which the top positions at British banks had been taken by people who had spent large amounts of time on the investment banking side of the business.[62]

39. One feature of the two different types of banking is in their compensation practices. Paul Volcker argued that:

the compensation practices that crept in, and the very large compensation in the trading parts of banks, infected the culture of the institutions generally, so the lending offices dreamt things up—how to make a lot of money in the short run and get a big bonus.[63]

This mindset may have particularly affected the treasury functions in retail banks, whose role had historically been to fund safely profit-generating activity elsewhere in the business, but in the run-up to the crisis the treasury function increasingly became a profit-centre in its own right. Professor Kay said of his experience at Halifax in the 1990s: "I thought that the road to nemesis essentially began at the point at which it was decided that the treasury operations of the bank should be a profit centre rather than a service activity for the business of deposit taking and mortgage lending".[64]

The case against structural separation

40. Structural separation is viewed as imposing additional operational costs on banks, in addition to the higher funding costs that will result from the curtailment of the implicit guarantee. According to the Treasury, in the case of the proposed ring-fence, "there will be upfront transitional costs (such as establishing new subsidiaries) and ongoing costs of operating two entities rather than one (such as operating separate IT platforms)."[65] These costs are estimated to be in the range of £1.7 bn to £4.4 bn a year, with one-off transitional costs in the range £1.5 bn to £2.5 bn.[66] Some witnesses criticised the way the Treasury's impact assessment calculated these costs, suggesting the real figure could be higher. RBS said "Like the ICB's cost/benefit analysis before it, the impact assessment tends to apply a narrower and more selective filter for the estimated costs than for the putative benefits".[67]

41. In the view of some, the costs of structural separation outweighed the modest gains in terms of stability and resolution over and above what could be achieved by improvements in banks' capacity to absorb losses and associated measures to discourage risk-taking. RBS argued that ring-fencing would bring "at best modest incremental gains in resolvability over and above the more targeted measures already in train through the recovery and resolution planning process".[68] Stephen Hester, Chief Executive of RBS, said he did "not think [ring-fencing] will produce any safety benefits to the financial system or the UK",[69] while Peter Sands, Chief Executive of Standard Chartered, also argued that "it will not deliver a stability benefit, and it will be more expensive".[70] This was also the view of Barclays in written evidence to the Treasury Committee in October 2011 when they suggested that ring-fencing:

has, at best, marginal benefits as a resolution tool over and above reforms already in place, underway, or in development, including the improvement and alignment of resolution plans and powers and improvements to loss absorbency requirements for banks at the global level.[71]

42. Barclays had also disagreed in 2011 with the suggestion that structural separation insulated retail banks from external shocks.[72] This view was echoed in evidence to us by Peter Sands:

The stability benefits are illusory, because what you are actually creating is more homogenous, less diversified entities that will have less resilience in times of stress.[73]

43. Some of those sceptical about the benefits of structural separation also point to the fact that destabilising losses can just as easily be concentrated on the supposedly "safe" side of a structural separation.[74] Thus, for example, the operations of several banks which failed or needed support during the crisis, including Northern Rock, HBoS, and Bradford & Bingley fell almost entirely within the traditionally understood functions of a retail bank. The Association of British Insurers summarised the view that the risky lending behaviour of banks in markets that are traditionally more associated with retail banking—such as in the real estate sector—was a more important cause of the recent crisis than the risk-taking by investment banks:

the universal banking model was not the root cause of the financial crisis [...] Within the UK, banking cycles have been closely correlated to real estate valuations and 'bubbles' rather than to investment banking cycles or structural limitations or weaknesses within universal banks.[75]

44. Some witnesses rejected the concept of cultural contamination, or said that the blame for many of the recent problems lay more with cultural influences arising within the retail side of banks.[76] Lord Turner told us that in his view "the culture of classic commercial banking was probably contaminated by three different things", only one of which was investment banking culture. Equally important in his view were two other factors:

it was polluted to a degree by the invasion of consumer goods companies' and retailers' approaches to banking in a way that is perfectly okay in retailing and consumer goods, but dangerous when you get to retail financial services products [...]

The third thing that was a pollutant was that, over the last 30 years, there has been a very strong tendency across business to have an overt focus on shareholder value and return on equity. [...]. But applied to banking that is potentially dangerous, because in banking the easiest way to boost return on equity is simply to boost your leverage either in direct open ways or in a set of hidden ways.[77]

The overall case for separation

45. The Commission finds the evidence that it has received on the benefits for financial stability of some form of separation convincing. The evidence that there has been damage to standards and culture by having these activities side by side, an area not examined by the ICB, is comprehensive and a crucial consideration. There is evidence to suggest that, as well as supporting financial stability and reducing the risk to the taxpayer, separation has the potential to change the culture of banks for the better and to make banks simpler and easier to monitor. These are propositions to which the Commission expects to return in the New Year.

Ring-fence proposals


46. A ring-fence attempts to secure some of the benefits of structural separation while maintaining some of the benefits of synergy and diversification held to exist in organisations undertaking both retail and investment banking operations.


47. The ICB proposed one particular form of a ring-fence. It recommended that activities "whose continuous provision is imperative and for which customers have no ready alternative" should be required to take place within a ring-fenced bank. Ring-fenced banks would not be permitted to engage in activities which either (a) are not integral to the provision of payments services or to intermediation between savers and borrowers, (b) directly increase the exposure of the ring-fenced bank to global financial markets, or (c) significantly complicate its resolution or otherwise threaten the objective of the ring-fence.[78] Any activities that were neither mandated nor prohibited could take place on either side of the ring-fence. In summary, the practical effect would be that:

  • activities required to be within the ring-fence should include taking deposits and providing overdrafts to individuals and SMEs;
  • prohibited activities should include what are broadly thought of as investment banking activities, including proprietary trading, market making, dealing in derivatives and underwriting securities; and
  • permitted activities could include wider customer banking activities such as retail and SME lending, taking deposits from customers other than individuals and SMEs and lending to large companies outside the financial sector.

48. The ICB's proposals would allow the ring-fenced bank to be owned by a wider banking group that conducts prohibited activities. In order to get the benefits of structural separation, the ICB set out a series of characteristics, required of the ring-fenced bank to ensure its independence from the wider group, including that:

  • it should meet capital and liquidity requirements on a standalone basis;
  • its relationships with the rest of the group should be conducted on a third-party basis;
  • it should have independent governance and make disclosures as if it were independently listed.[79]


49. Another approach to a ring-fence was more recently set out by the High-level Expert Group on reforming the structure of the EU banking sector, chaired by Erkki Liikanen (the Liikanen Group), which produced its report on 2 October 2012. This Group recommended a form of structural separation similar to that proposed by the ICB. The way the Group's report describes the proposal focuses on the risky activities which are being separated off, rather than the core activities which are being protected. As Martin Taylor, a member of the ICB, expressed it:

In a sense, we are trying to put a fence round the deer park and Liikanen is trying to cage the wild animals. It comes to the same thing in the end. I thought the Liikanen report very interesting and highly compatible in many ways with Vickers.[80]

The Liikanen Group proposal allows a broader range of activities to take place alongside deposit-taking than the ICB ring-fence. In particular it allows underwriting of securities, which in the UK would be viewed as an investment banking activity. Sir John Vickers voiced his surprise that the Liikanen Group had chosen to permit underwriting within the deposit-taking bank,[81] but Erkki Liikanen argued that "universal banks as a whole have served the European economy well when they have acted with prudence". He said that his proposals aimed to preserve the benefits of the universal bank while protecting such banks from high-risk activities:

If you study the history of banking you will see that universal banks are quite recent in the United States, but they are historical in Europe—they have existed since the 19th century. By universal banks, we mean banks that are able to offer all types of services to their corporate clients and to households. What has happened since 1990 is that some of the universal banks have changed, in the sense that, while their deposit base remained more or less the same and their lending to households was not very different, they rapidly extended their investment banking activities, especially in proprietary trading and market making.[82]

Full structural separation


50. Full structural separation, in contrast to a ring-fence, requires certain activities to take place in completely separate organisations, not just different subsidiaries of the same group. The bank which provides retail deposit-taking services cannot be in the same corporate group as an entity which undertakes certain risky activities. As with the ring-fence, there are various models, both current and historic, which determine how full separation should or can be defined.


51. The proposed Volcker rule, which is being implemented through the Dodd Frank Act, excludes some activities from the banking group altogether, but sets out a much narrower range of prohibited activities than the ICB or Liikanen proposals, focusing just on proprietary trading and investment in hedge funds or private equity funds. Proprietary trading is held to be bank speculation on the market with its own funds. Paul Volcker explained to us that he viewed all customer-related activities as belonging together—even those, such as underwriting or market making, which might be regarded as investment banking—because of the enduring relationship and fiduciary duty to the client that these involve. In contrast, proprietary trading involves an impersonal relationship with counterparties, and should not take place within the same entity.[83] Martin Taylor contrasted the effect of the Volcker rule on banks with the effect of the proposal ultimately put forward by the ICB:

We obviously looked at the Volcker rule, because it was pre-existent. [...] We did not see that it would solve the problem we were trying to solve. [...] A Volcker rule is of course a lot less radical from the banks' point of view than a ring-fence.[84]

52. One possibility which was raised by some witnesses was that of combining the ICB ring-fence with a Volcker rule, in order to exclude from even non-ring-fenced banks the kind of speculative trading activity which causes the greatest concern.[85] Lord Turner said that he believed it should be possible to discourage undesirable trading book risks by increasing the capital requirements against it, but added "I am not completely against a three-step solution. [...] I think that if we observe that Volcker-rule proprietary trading does work in the US, I would not necessarily exclude it".[86]


53. The forerunner to modern proposals for full structural separation was the Glass-Steagall Act passed in the US in 1933, which included provisions prohibiting banks which accepted deposits from engaging in securities-related activities.[87] As Paul Volcker summarised it:

Glass-Steagall was originally a very simple law. I am simplifying a bit, but it only had a paragraph or two that said a bank can't trade. With the exception of Government securities and a few other things, you cannot hold a trading security in your account. You can act as a broker for a customer but you can't deal with it.[88]

The range of activities which retail banks were prevented from conducting was closer to the ICB proposal than either the Liikanen Group proposal or the Volcker rule, in that Glass-Steagall as originally enacted excluded retail banks from both underwriting and market-making.[89] The US approach under the Glass-Steagall Act was to separate activities so that deposit taking and prohibited activities took place in fully separate organisations, with tighter restrictions on how each is owned, although these restrictions were loosened over time, with the relevant sections of the Glass-Steagall Act that required full separation being repealed in 1999.

Summary of separation options
54. The table below provides a necessarily simplified comparison of the broad principles of four versions of structural separation.[90] Grey and dark blue activities must be conducted in separate entities. White activities can be conducted in either:

Before assessing the merits of the options, the next two chapters describe the Government's proposed approach to giving effect to its preferred approach and consider the challenges to which any form of structural separation will be subject in the long-term.

42   Independent Commission on Banking, Interim Report, April 2011, p 76 Back

43   Q 983 Back

44   Independent Commission on Banking, Final Report, September 2011, p 9 Back

45   Q 860 Back

46   Q 453 Back

47   Q 355 Back

48   Independent Commission on Banking, Interim Report, April 2011, p 76 Back

49   Treasury Committee, Fifth Report of Session 2012-13, The FSA's Report into the failure of RBS, HC 640 Back

50   Q 647 Back

51   Q 636 Back

52   Q 452 Back

53   Independent Commission on Banking, Interim Report, April 2011, p 76 Back

54   Qq 784, 795 Back

55   Q 62 Back

56   Q 64 Back

57   Memorandum from Sir Alan Budd, 8 October 2012 Back

58   Q 588 Back

59   Ev w86 Back

60   Q 455 Back

61   Q 358 Back

62   Q 295 Back

63   Q 61 Back

64   Q 294 Back

65   HM Treasury, Sound banking: delivering reform, Cm 8453, October 2012, Annex B: Impact Assessment, para 20 Back

66   Ibid., para 27  Back

67   Ev w110 Back

68   Ev w101 Back

69   Q 855 Back

70   Q 859 Back

71   Treasury Committee, Independent Commission on Banking Final Report October 2011, Oral and Written Evidence, HC (2010-2012) 1534, Ev 130 Back

72   Ibid. Back

73   Q 860 Back

74   Ev w110, para 7.1  Back

75   Ev w25 Back

76   Qq 449 [Douglas Flint], 451 [Anthony Jenkins], 753 [Sir John Vickers], 861 [Stephen Hester], 1164 [Paul Tucker] Back

77   Q 967 Back

78   Independent Commission on Banking, Final Report, September 2011, p 11 Back

79   Independent Commission on Banking, Final Report, September 2011, p 12 Back

80   Q 391 Back

81   Q 854 Back

82   Q 100 Back

83   Qq 58, 64, 68 [Paul Volcker]; Memorandum from Paul Volcker, October 17 2012, para 2. Back

84   Q 390  Back

85   Qq 390 and 753. Back

86   Q 963 Back

87   Banking Act of 1933 (Pub. L No. 75-66, 48 Sta. 162); Section 21 of the Banking Act 1933 (12 U.S.C. 24 (Seventh)) Back

88   Q 74 Back

89   Banking Act of 1933 (Pub. L No. 75-66, 48 Sta. 162); Section 21 of the Banking Act 1933 (12 U.S.C. 24 (Seventh)) Back

90   The Volcker rule (section 619 of the Dodd-Frank Act) only looks at proprietary trading and investments in hedge funds or private equity funds and effectively prohibits US Banks, Bank Holding companies and their non-banking subsidiaries engaging in these activities. This relates to Glass-Steagall (the US Banking Act of 1933) as originally enacted. For reference to subsequent changes, see next chapter, paragraph 73. Back

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Prepared 21 December 2012