Banking StandardsWritten evidence from Which?

Executive Summary

Which? strongly supports the full and robust implementation of the Vickers proposals for ring-fencing retail banks. Essential retail banking services on which consumers and small businesses rely should not be put at risk by imprudent behaviour elsewhere in large banking groups. There is also an urgent need to limit the scope of the implicit taxpayer guarantee for large banking groups and the distortions to competition arising from this subsidy.

We welcome the Government’s stated intention of “comprehensive and far reaching reform”. However, the Draft Bill provides a significant amount of discretion to the Treasury and regulators to implement ring-fencing. This leads to the following concerns:

The draft Bill only allows the Treasury to make an order prohibiting an activity in a ring-fenced bank if it is “necessary or expedient” to protect the continuity of the provision of “core services”.

The precise boundary between technical and non-technical matters is not clear.

The Government’s intentions for the consultation arrangements for secondary legislation is not clear.

The lack of a proper, agreed process of parliamentary scrutiny for the secondary legislation.

The lack of accountability for the PRA, which currently is only required to consult firms and banks on its proposals.

The lack of a properly focused objective for the PRA to promote effective competition.

We have the following comments on the other issues raised by the draft Bill:

Large banks: Despite ring-fencing, resolution arrangements for the largest banks are still not credible. The scale of banks currently operating poses dangers for both stability and competition. An immediate referral to the Competition Commission is the best way to resolve this issue.

High-net worth individuals: The threshold above which individuals may opt-out of placing deposits in a ring-fenced bank should be substantially higher. We also recommend the introduction of an advice regime for deposits in non-ring-fenced banks and for non-ring-fenced banks to be required to use the term “fixed-interest securities” and “variable-interest securities” to avoid any possibility of confusion.

Financial product restrictions: There are significant risks in allowing ring-fenced banks to sell derivatives to their customers and a prohibition may be the simplest way of controlling these risks. They should be prohibited from selling their own subordinated or senior unsecured debt or that of a linked non-ring-fenced bank directly to their retail customers. This should include a prohibition on selling structured products or any derivatives based on any of those types of debt.

Governance: The directors of both the ring-fenced bank and the wider group will need to be given specific duties to preserve the integrity of the ring-fence. It should be made clear to the directors that they will automatically be subject to individual regulatory action if they fail to uphold this duty.

Leverage ratio: We disagree with the Government’s proposals not to apply a higher leverage ratio to large ring-fenced banks.

Depositor preference: We support depositor preference, although the Government is proposing to implement a narrower definition, only covering insured depositors. There also needs to be reform to the FSCS to make it easy to understand by providing protection for each brand and coverage for temporary high balances.


1. Which? established and supported the Future of Banking Commission, chaired by Rt Hon David Davis MP. In addition to taking evidence from senior regulators, banking executives and academics, the Future of Banking Commission included the Which? big banking debate—an event attended by 300 members of the public and allowed consumers to make their own submissions on our website. The report was published on 13 June 2010 and made a series of recommendations for changes to the structure, regulation, governance and culture of the banking industry.1

1. Does the draft Bill successfully give effect to the objectives set out in paragraph 1.3 of Sound banking: delivering reform and is it the most efficient and effective means of delivering those objectives?

2. No, the draft Bill does not sufficiently give effect to the objectives set out in paragraph 1.3. Which? strongly supports the principle of ring-fencing of essential retail banking services. However, the lack of detail in the draft Bill, together with the substantial delegation of authority to both the Government to set the detail in secondary legislation and the PRA to set the rules for ring-fencing means that the Bill alone will not ensure that the objectives will be achieved.

3. We welcome the Government commitment to introducing ring-fencing as part of the Banking Reform Bill. The broad nature of the draft Bill leaves the risk that the lobbying power of the major banks and the inevitable concessions during the Bill’s Parliamentary passage may see it watered down before it is implemented. We highlight the following concerns about the PRA.

4. Accountability and governance of the PRA: The PRA will be responsible for making the rules governing ring-fencing. In this regard it is extremely worrying that the PRA only has a duty to consult banks and other firms when making rules. This empowers the PRA to only take the views of banks into account when formulating the rules.

5. Lack of a properly focused competition objective for the PRA: The PRA should be given a specific duty to promote effective competition in the interests of consumers. Appropriately, the PRA will have a general objective to promote “safety and soundness”. However, there is no mention of competition in its objectives even though it will be required to make decisions that will have an impact upon competition. This means that the PRA will not be required to consider the competition consequences of its decisions.

6. We agree with the Government regarding the need to curtail implicit government guarantees and their distorting effect on competition. However, the Government has not given the PRA an objective to promote effective competition or to limit the extent of the implicit government guarantee. To ensure that the PRA operates in line with Government policy we believe its objectives should be amended to give it a role in these two areas. In addition to being given a specific objective to promote effective competition the PRA should be required to report every year on the size of the potential implicit subsidy, the progress with implementing the ICB’s recommendations and what progress has been made in reducing the implicit subsidy. It is also important to note that the PRA will have a role in activating the Special Resolution Regime. Currently, the objectives of the SRR contain no mention of the desirability of promoting competition.

7. The PRA will also have responsibility for issuing banking licences. Without a statutory obligation to consider competition, the PRA will not have an incentive to encourage new entrants to the market or reduce significant barriers to entry for new players. Challenger banks are vital to invigorating the market and improving conditions for consumers. For example, when Metro Bank launched, it promised to give current account holders their new debit card in branch when they opened their account. This forced other banks to reassess their own account opening procedures and compete against the service provided by the new challenger. This small example typifies the benefits that new entrants and effective competition can bring to consumers.

8. Challenger banks can invigorate the market and force existing players to compete for custom by introducing new products and services. This should create a more dynamic market in which good firms will grow. The FCA has an objective to promote effective competition. In the interests of regulatory synchronicity the PRA should be given an equivalent competition focus.

9. The Joint Committee that scrutinised the draft Bill recognised the importance of competition in decision making at the PRA:

Competition within the financial sector is an important part of developing a stronger, more diverse system. The actions of the PRA have the potential to affect the costs of individual firms or of particular types of institution, and affect the barriers to entry and expansion in the market. While the need to protect and promote competition in the sector should not dictate the actions of the PRA, nor detract from the clear role of the OFT in this area, we believe it is a factor that ought to be considered in the course of PRA decision making.

2. Do any of the recommendations of the Independent Commission on Banking (ICB), which the draft Bill seeks to implement, need revision as a consequence of developments since the ICB’s report?

10. The ICB’s recommendation surrounding the Lloyds divesture should be reviewed as a consequence of developments since the ICB’s report. Even after the existing sale of Lloyds branches to the Co-operative, Lloyds Banking group will still be left with a significant market share in current accounts, mortgages and savings. It is important to note that it has not achieved this large market share by offering customers good value products or by being efficiently run. Rather, it has achieved its dominant position through Government subsidies, bail-outs and a suspension of normal competition law. The scale of the largest banks now operating poses dangers for both stability and competition. It is clear that a bank such as Lloyds Banking Group, which is responsible for a significant amount of credit provision within the economy will not be allowed to fail and will never be subject to resolution.

11. The Competition Commission is the only body with the power to restructure major banking groups. An immediate referral to the Competition Commission would provide a clear process for doing so, with consequent benefits for both effective competition and financial stability.

3. Do the powers in the draft Bill and the Government’s stated intentions for their use give effect to the ICB’s recommendations? Are any deviations justified?

12. Please see our comments below.

4. What should be the timetable for implementation of these measures, and should it be set out more clearly?

13. The Government should set out a more detailed timetable for implementation of these measures during the process of Parliamentary scrutiny. Our preference would be for implementing the ring-fencing proposals earlier than 2019. Any delay increases the risks to the Government’s AAA credit rating from the possibility of having to support the major UK banks. However, when considering the timetable of implementing the measures for enhancing capital requirements, the Government should give consideration to any short-term impact on the volume of lending in the economy.

5. The draft Bill proposes continuity objectives on the PRA and FCA. Are these appropriate and compatible with their other objectives?

14. We are slightly concerned by the lack of a definition of “continuity” in the legislation. The document itself defines continuity as the “uninterrupted provision of vital banking services”.2 This might be a better definition to use.

15. With regard to the PRA, we are concerned that the current recovery and resolution plans contain little information about how customers will be treated during the resolution process. It will be important that these aspects are considered by the PRA.

Banking Standards and Competition

6. What will be the impact of the proposed changes in the draft Bill on banking standards in the UK more widely?

16. The course of history suggests that financial crises will recur at regular intervals and that it is not helpful to completely eliminate the risk of failure (or to claim that a Government or regulator will eliminate the risk of failure in all circumstances). The current corporate structure of the UK banking system allows banks to take retail deposits and be an essential part of the payments system, while at the same time engaging in all manner of risky and speculative investment banking activities including proprietary trading.

17. This corporate structure helps to create banking institutions that are “too big to fail” and results in the Government (and ultimately taxpayers) guaranteeing that these banks will continue in business. The implicit (and in reality explicit) taxpayer guarantee encourages banking corporate structures which intertwine highly leveraged wholesale investment banking activities with retail deposits and the payment system. When these, large complex banks are at risk of failure, in the past the Government has had little choice but to extend support to the full spectrum of retail and investment banking activities. The result has been that the UK taxpayer has provided guarantees against losses by banks on loans they made to hedge funds based in the Cayman Islands and losses on trading of complex derivatives.

18. Subsidies will inevitably be greater for those banks with low professional standards. This makes banking unique from other sectors. In no other sectors that we examine do firms actively obtain a government subsidy for behaving badly. The corporate structure also results in taxpayers paying the costs of low banking standards as they end up owning a majority stake in poorly run banks with the lowest level of banking standards.

19. If the draft Bill reduces the level of subsidy and taxpayer support for banks with low levels of banking standards then should, in the longer term, improve the level of banking standards. However, this would require full and robust implementation of the ring-fence. It should also be noted that the timetable for implementation will mean that the draft Bill could take a significant amount of time to lead to improvements in standards.

7. What will be the impact of the separation of retail and wholesale banking on the culture prevailing within each?

20. Strong governance arrangements for ring-fenced will be necessary to achieve the following objectives:

To prevent the extraction of value from the ring-fenced bank into the remainder of banking group.

To protect the integrity of the ring-fence and ensure the continuity of essential banking services for consumers and SMEs.

To ensure that the culture of the ring-fenced bank is separate and insulated from the investment banking culture in the other parts of the banking group.

To impose a credible threat of failure on the non-ring-fenced bank.

21. Accomplishing these objectives will require the Board of the ring-fenced bank to be demonstrably independent of the wider banking group. The directors of both the ring-fenced bank and the wider group will need to be given specific duties to preserve the integrity of the ring-fence. It should be made clear to the directors that they will automatically be subject to individual regulatory action if they fail to uphold this duty.

22. The ring-fenced bank should also be required to maintain independent nominations, risk, audit and remuneration committees, with the chairs of those committees having no link to the rest of the banking group. To prevent undue influence on the incentive structures set in the ring-fenced bank, it is important that the remuneration committee of the ring-fenced bank does not contain any executives from the wider banking group.

8. What will be the impact of the ring-fence on competition, both in retail and investment banking, and in other areas of financial services?

23. If the implementation of the ring-fence makes it more likely that poorly-run banks will be allowed to fail then it should have a positive effect on competition, both in retail and investment banking. However, the positive impacts on competition may be mitigated by the lack of a clear objective for the PRA to promote effective competition.

Delegated Powers and Accountability

9. The draft Bill grants a large number of delegated powers to the Government. Are the principles under which delegated powers are to be exercised sufficiently clear?

10. Does the scope of the delegated powers in the draft Bill represent an appropriate balance between flexibility for the Government to respond to changing conditions and accountability to Parliament and the public?

11. Is there sufficient clarity about the Government’s intended use of delegated powers, both to enable public understanding and to enable affected banks to prepare for the proposed changes?

24. The Bill sets out that the Treasury will be responsible for setting the scope of the ring-fence (its “location”) and the regulator responsible for determining its “height”. However, the document also states that the “Treasury may confer powers upon the appropriate regulator to determine technical matters, according to the purposes set out in primary and secondary legislation”. We would highlight the following points:

The draft Bill only allows the Treasury to make an order prohibiting an activity in a ring-fenced bank if it is “necessary or expedient” to protect the continuity of the provision of “core services”. It is not clear what burden of proof will be used by the Treasury. The draft Bill also allows the Treasury to make exceptions by stating “circumstances in which it may be necessary or desirable to permit a ring-fenced bank to undertake an excluded activity.”

The precise boundary between “technical” and “non-technical” matters is not clear.

The Government’s intentions for the consultation arrangements for secondary legislation is not clear.

The lack of a proper, agreed process of parliamentary scrutiny for the secondary legislation.

25. When combined with the concerns about the lack of accountability for the PRA and the absence of a competition objective, it could lead to a concern that the ring-fencing requirements could be watered down.

12. The draft Bill provides for review of the ring-fencing rules by the PRA every five years. Does the proposed review mechanism provide sufficient accountability?

26. We do not believe that the proposed review mechanism provides sufficient accountability for the PRA. A time period of 5-years from when the first rules come into place is far too long before the PRA begins to assess the implementation of the policy. The proposed review mechanism should include the following:

Before the first implementation of the ring-fencing rules, the PRA should be required to publish a full evaluation timetable for the ring-fencing rules. This should be consulted on with academics, consumer groups and the public in addition to firms and banks.

This should include a full list of the desired outcomes and objectives the PRA is seeking to achieve with the implementation of its ring-fencing rules. It should also specify the short-term and long-term indicators which the PRA will use to assess whether its objectives and outcomes are achieved.

The PRA should be required to measure and report annually on the extent of the implicit subsidy from the taxpayer guarantee, the extent to which it is distorting competition and what progress has been made in reducing the subsidy.

Yearly progress updates should be published by the PRA with the report of these updates given to the Treasury and laid before Parliament.

The Ring-Fence

13. Is the power to be able to exempt certain categories of deposit-taking firms from having to establish a ring-fenced bank appropriate, and on what basis should the conditions for exemption be set?

27. Any exemption from ring-fencing should not be open to abuse by banking groups by splitting their bank into smaller separate entities. Any threshold should be set by reference to the amount of deposits within the bank. On balance, £25 billion may be too high as it would allow banks of a significant size to benefit from the Government guarantee without a requirement for ring-fencing.

14. Is the range of core and excluded activities defined in the draft Bill appropriate and sufficiently broad? Are the Government’s stated intentions for using powers to define further core and excluded activities appropriate?

Restrictions on selling retail investment products

28. There should be restrictions on the ability of ring-fenced banks to sell retail investment products. The Government should ensure that ring-fenced banks are unable to sell their own subordinated debt or senior unsecured debt or that of a non-ring-fenced bank from within the same group. We are concerned that banks such as Santander are using their retail arm to sell structured products such as this to their retail customers. In the past, Barclays has also sold a number of such products, including an account which was listed as an “Investment ISA” but was actually the senior unsecured debt of Barclays group.

29. Allowing ring-fenced banks to sell their own subordinated debt or that of a non-ring-fenced bank within the same group would lead to a significant conflict of interest. Banks would not be willing or able to ensure that such debt was priced appropriately and would be likely to mis-represent its nature to consumers and disguise the true risk the consumer was taking. It would also not be realistic to expect consumers buying this debt through retail branches to impose any effective market discipline on banks with riskier activities.

30. The sale of subordinated debt and structured products based on subordinated or senior unsecured debt to retail consumers could also pose a significant barrier to resolution. This could occur if the Government viewed itself as unwilling or unable to impose losses on ordinary retail consumers who had purchased this debt. It could also occur if imposing losses on consumers who had bought this debt would result in substantial legal claims against the bank due to the fact that the bank had failed to ensure that such investments were suitable for the consumer. Spanish consumer groups are currently dealing with the problem of thousands of retail consumers who were mis-sold risky preference shares by Spanish savings banks. The widespread retail holdings of these products have complicated attempts to place the Spanish banking system on a sustainable footing. If ring-fenced banks mis-sell a large amount of these products to retail customers then it is likely to pose a significant barrier to “bail-in” or resolution. Any attempt to impose losses on retail consumers will lead to the bank facing uncertain and potentially large legal liabilities.

31. In recent years a number of banks have sold inappropriate structured products through their retail branches. These have included:

32. Barclays five-year fixed income bond (with the option to invest in an ISA)—This was actually a Barclays corporate bond and exposed the consumer to credit risk of Barclays group. It was advertised as offering a “potentially higher return than most savings accounts”.

33. Barclays Defined Returns Plans, which offered returns linked to the performance of the FTSE 100, but actually involved consumers accepting counterparty and credit risk from Barclays Group. These were described to our mystery shopping researchers as “no risk investments” where “your capital is 100% guaranteed”

34. Santander are offering products, including calling a product “Protected capital plus”, when it is not subject to the FSCS. The Key Features documents for their structured products are potentially misleading as they include frequent references describing capital as “guaranteed” and describing the individual structured products as a “very low risk investment.” We were also concerned that the so-called guarantee was provided by “Santander Guarantee Company” which was in fact dependent on Santander UK. In our mystery shopping, Santander staff described these products as offering “a guarantee on your investment so you can’t lose a penny” and “Capital is guaranteed at 100%” and “they’ll guarantee your money back”.

35. It is also important that both ring-fenced and non-ring fenced banks are not able to sell any other financial product which purports to offer a guarantee of a consumer’s capital but which are not covered by the FSCS.

Structured deposits

36. We are also concerned about poor value and misleading structured deposits sold by UK retail banks and building societies. In the short term, structured deposits should be brought within the scope of MIFID and we agree with the Government that extensive use of these products could expose banks to increased risks. There should limits on the ability of ring-fenced banks to sell structured deposits.

15. Which categories, if any, of customer should be permitted to deposit with a non ring-fenced bank?

37. Which? believes that the threshold for high-net worth individuals should be as high as possible. We suggest a figure of at least £2 million net financial wealth (after deducting debt). We do not see any significant benefits to individual consumers from placing their deposits in a non-ring-fenced bank. These “deposits” in the non-ring-fenced bank would not be covered by the FSCS and would not be “preferred” as they would rank equally in line with wholesale creditors in any resolution. In our view, it is very unlikely that these individual depositors will be able to offer any meaningful form of market discipline on these non-ring-fenced banks, by demanding higher returns from riskier banks.

38. We are concerned that a measure of “free and investable assets” with a single bank may provide too much leeway for individuals to be inappropriately advised to use a non-ring-fenced bank. For example, under the Government’s current criteria an individual with a substantial amount of debt outstanding to another bank could meet the definition. By only assessing the level of free and investable assets with one bank, the Government is also ignoring a key recommendation of the ICB that such individuals should not be able to use a bank where even a temporary interruption would have a significant economic cost. Where a customer only has free and investable assets of £250,000 and places them all with a non-ring-fenced bank, any interruption of access to those assets or subjecting them to loss would have a significant economic impact on the individual consumer.

39. There is also the issue that the FSA handbook does not contain any specific provisions regarding the provision of advice to consumers around deposits. This would mean that non-ring-fenced banks would be free to recommend their deposits to any consumer who met the criteria, without assessing the customer’s attitude to risk or investment goals. If the Government decides to proceed with the high-net worth exemption it is imperative that an advice regime for deposits in non-ring-fenced banks is introduced. Finally, we question whether the term “deposit” is an appropriate term to use. There is significant scope for confusion if both non-ring-fenced and ring-fenced banks are allowed to operate from a single bank branch/website. We would prefer a term such as “fixed-interest securities” or “variable-interest securities” so that they are clearly differentiated from insured deposits held in ring-fenced banks.

16. The Government is considering whether to allow ring-fenced banks to offer simple derivatives to their customers. Should they be allowed to? If so, what safeguards would be necessary?

40. Ring-fenced banks will have a unique role in providing parts of the economy with credit. If they want to borrow money, consumers and small businesses typically have few alternatives to these banks.3 It is important that these banks are not able to take advantage of this unique position by making the provision of a loan depend (or appear to depend) on the purchase of an ancillary product such as insurance or derivatives. This has three important impacts, firstly if ring-fenced banks are allowed to sell derivatives then they could be used to extract value from the ring-fenced bank to the wider group. Secondly, they could make the ring-fenced bank less stable if the money gained from selling the derivative is used to cross-subsidise riskier lending. Thirdly, there is the risk of derivatives being sold inappropriately leading to subsequent payments of redress which might destabilise the ring-fenced bank. These impacts were all caused by the mis-selling of Payment Protection Insurance.

41. Restrictions on ring-fenced banks selling derivatives would not prevent those banks from offering fixed-rate loans. However, they would prevent the bank from selling a consumer a variable rate loan and a separate linked derivative to fix their payments.

17. Are the proposed corporate governance arrangements between the ring-fenced bank and the wider group sufficient to ensure the independence of the ring-fenced bank? Are these arrangements compatible with directors’ duties and principles of accountability?

42. This will be impossible to determine until the relevant rules are consulted upon by the regulator. The current draft Bill contains a provision for the PRA to make rules including provision “about the corporate governance of the ring-fenced body with a view to securing as far as practicable its ability to act independently of other members of the group.”4 The presence of the term “as far as practicable” will give the regulator a significant amount of discretion to water-down the requirements.

43. We believe that the demonstration of independence is best achieved by requiring the ring-fenced bank to make disclosures as if it were independently listed on the London Stock Exchange. We are concerned that under any other proposal, the ring-fenced bank may not be required to disclose appropriate information as it might be part of a much larger banking group such that the information is not considered to have a significant effect on the overall share price of the banking group.

44. The ring-fenced bank should also be required to commission an independent audit of the integrity of the ring-fence and publish this in full alongside its annual report.

45. We are also concerned that in the run-up to the implementation of the ring-fence there may be a lack of clarity about where possible liabilities for legal or regulatory action will lie if they crystallise in the future. It is important that at the process of separation the banking group is unable to load potential future liabilities onto the ring-fenced bank, because of poor past conduct in the wider banking group.

18. How appropriate are the proposed restrictions on exposures and operational dependencies between the ring-fenced bank and the rest of the group? Will these result in a sufficient degree of independence and resilience?

46. We support strong restrictions on exposures and operational dependencies between the ring-fenced bank and the rest of the group. The Treasury has delegated the development of these rules to the regulator, which at this stage, makes it difficult to say that these will result in a sufficient degree of independence and resilience.

47. The assumption in the impact assessment that ring-fenced banks will be able to have an exposure to their group of up to 25% of their regulatory capital is unlikely to ensure a sufficient degree of resilience.

19. Will it be possible to effectively monitor and police the ring-fence, given the degree of regulatory discretion the draft Bill proposes?

48. The significant degree of regulatory discretion the draft Bill proposes, combined with the inherent complexity of the ring-fencing rules may make it difficult to monitor and police the ring-fence. The Commission should consider the evidence from Andy Haldane, Executive Director of the Bank of England, that complexity in regulation can raise questions about the robustness of the framework. We would also highlight that a complex framework suits those banks which are able to devote significant time and resources into lobbying for changes to the framework. It also makes it more difficult to monitor the performance of the regulator.

20. How effective will the provisions on corporate governance for ring-fenced banks be in promoting a wider improvement of standards? Should other measures also be considered?

49. The provisions on corporate governance within ring-fenced banks are, on their own, unlikely to promote a wider improvement of standards.

Depositor Preference

21. Is the proposal to prefer insured deposits in the event of a bank insolvency justified? Is there a case for broadening the scope of deposits which benefit from this protection?

50. We support reform to the bankruptcy procedures so that depositors become a higher ranked creditor than senior unsecured credit (depositor preference) and so that bondholders become exposed to the true credit risk of the bank that they are lending to. Retail depositors are not well placed to evaluate the credit risk of the bank in which they place their deposits. They are therefore not able to provide the proper incentives to encourage bank management to control risk. It is also important to note that the costs of the FSCS levies are ultimately paid for by bank depositors as a whole or taxpayers.

51. In the Irish banking crisis senior members of the Irish government attempted to reassure senior unsecured creditors by saying that they ranked equally with depositors and that they would not be subject to a write-down unless depositors were affected in a similar way.5 This should be extremely worrying for the position of depositors in Irish banks. When the Irish Government introduced its so-called deposit “guarantee” we were clear that there was “no guarantee that the protection that has been offered by the governments in question will be forthcoming. It may be, for example, that the government cannot afford it or decides to exclude overseas savers. Consumers should not move their savings to any foreign country or bank on the strength of these guarantees.”6

52. The Government’s chosen form of depositor preference covers only insured depositors and no depositors outside the scope and limits of the deposit insurance system. The uninsured amount of a deposit will be treated as an unsecured senior creditor claim. This approach could have the advantage of limiting the application of depositor preference to the level covered by the FSCS. However, it has the disadvantage of excluding retail depositors who hold levels above the limit from benefiting from depositor preference. This will reduce the willingness of the Government to impose losses on wholesale creditors and bondholders if they rank pari passu with deposits above the limit. It is also clear to us that there are many occasions during a person’s life when they need to hold deposits above the level set by the FSCS. These could include house purchase/sale, receiving an insurance pay-out, inheritance or pension lump-sum. We believe that at such times, retail depositors are not well placed to impose market discipline on banks and the loss of a deposit would risk having a catastrophic effect on the individual.

53. We can see a benefit from including charities within the definition of preferred deposits.

54. We are opposed to giving any preference to banks’ own pension funds. This would place the retirement benefits of senior executives at the same level as ordinary depositors.

Deposit insurance schemes

55. The events of the financial crisis have shown that the current system does not go far enough to protect consumers. Whilst steps are already being taken to tackle some of the weaknesses in the current system, Which? believes that these reforms need to go further in order to ensure that consumers retain confidence in the banking system. To ensure that this is the case the deposit insurance scheme needs to provide absolute clarity to consumers.

56. The UK retail ring-fencing proposed by the Government increases the need for the deposit insurance scheme to fulfil this objective. If this not the case then consumers may react to the failure of a non ring-fenced bank by withdrawing their deposits from the UK retail ring-fenced bank.

57. Research by the FSA7 found that awareness of the UK scheme was very low, even after the collapse of Northern Rock, and almost nobody involved in the interviews or focus groups undertaken knew any details about how the scheme actually worked.

58. If the Deposit insurance scheme proceeds on the basis of coverage per licenced institution, a consumer who has several accounts with different brands covered under the same licence will only be compensated up to £85,000. We are concerned that consumers will not be able to understand the complexities that this approach introduces. Given the plethora of different brands it is extremely difficult for consumers to understand the corporate structure of a bank and determine whether their money is protected. For example, brands including Halifax, Bank of Scotland, Birmingham Midshires, Intelligent Finance, AA Savings and Saga are all covered by a single licence.

59. The lack of consumer understanding was confirmed in research carried out by the UK regulator, the Financial Services Authority, which showed consumers “identified the brands as being different entities, leading to an assumption that all separate brands would be treated separately for the purposes of compensation”. The FSA research found that “The discovery that this separation might apply, but could not be taken for granted, was a shock that prompted considerable criticism of both the system and the banks which had a single authorisation across brands. This was seen as unfair at best and underhand at worst, a practice intended to benefit the banks at the expense of their customers.” The FSCS awareness campaign was unsuccessful in improving awareness of the scheme because of the complex message it sought to present to consumers.

60. Which? believes that the Government should ensure that deposit protection should be on a per brand basis. We were pleased to see the European Parliament vote through an amendment to the Deposit Guarantee Scheme Directive which will allow national regulators to apply the protection limits to brands rather than institutions. We urge the Government to support this important amendment in Council as the UK and other Member States develop their response to the Parliament’s position.

61. There will also need to be clearer warnings for consumers that exceed the deposit protection limit.

Capital Levels

22. Does the draft Bill adequately implement the ICB’s recommendations on loss absorbency requirements?

23. The draft Bill gives the Government power to direct the way in which the regulators can implement loss-absorbency requirements. How appropriate and well-designed is this power?

24. Is the Government’s stated intention for the design of loss-absorbency requirements workable? Will it provide a sufficiently well-capitalised banking system? In particular, how justified is the intention to allow an exemption for assets held in overseas operations?

25. Is the Government justified in its decision not to implement the ICB recommendation for a higher leverage ratio than is required by Basel III?

62. We disagree with the Government’s proposals to not apply a higher leverage ratio to large ring-fenced banks. This will allow large ring-fenced banks to run substantial and potentially excessive leverage. This poses a substantial risk that taxpayers will be forced to step in to provide them with guarantees in the event of their failure. Recovery and resolution plans can never be credibly used for large institutions as there would be too much of a damaging impact on the economy. For example, Lloyds Banking group8 will never be subject to a Recovery and Resolution plan due to the amount of credit it provides to customers. These factors strengthen the argument for applying a higher leverage ratio to large ring-fenced banks.

63. More generally, we are sceptical that setting capital requirements with respect to risk-weighted assets will ever be effective. As noted by the ICB “the amount of capital that banks are required to hold is dependent on the way in which assets are risk-weighted. This produces an incentive for banks to try and exploit this by choosing the riskiest assets for a given risk-weight.” This aspect was also clearly illustrated in the run-up to the financial crisis with banks increasing their leverage in ways which did not show up in the conventional measures of risk-weighted assets and tier 1 capital.9 The risk of banks undertaking this sort of exploitation of the risk-weighting framework is increased if senior management are given incentives to maximise returns on risk-weighted assets.10

64. More broadly, we are concerned that, in itself, designating a bank as “systemically important” is likely to significantly distort competition. It may provide an unreasonable degree of reassurance to market counterparties, other banks and retail and business customers that the bank will not be allowed to fail. Some consumers believe their deposits to be more at risk in new entrants than in conventional long-standing banks. This impact even extends to supposedly more sophisticated companies who are managing money on behalf of consumers. Hargreaves Landsdown states that when deciding which banks to use for the holding of client money it prefers “those which we believe the government would fully support in any further financial crisis.”11

65. One approach may be to set the additional capital requirements for “systemically important” banks in a way which offset this competitive distortion with an objective to ensuring a level playing field between “systemically important” and “non-systemically important” banks.


26. Will the UK authorities have the necessary tools and powers (as a result of this legislation and other initiatives) to be able to resolve a large failing ring-fenced or non-ring-fenced bank, while maintaining financial stability and minimising the risk to public funds?

27. What is your assessment of the Government’s preferred design of “bail-in” powers needed to improve bank resolution? How likely is it that the Recovery and Resolution Directive will deliver effective bail-in powers?

66. The draft Bill does nothing to enhance the likelihood of the UK authorities placing a large failing institution into the resolution process. There appears to have been little consideration of the interaction between competition and stability and the risks posed to both by the overall size and market position of Lloyds banking group.

67. With regard to enhancing resolvability, the introduction of portable bank account numbers could provide the authorities with an important tool. Portable account numbers could enable the quick and easy transfer of accounts from a failing bank. This issue should be considered by Government and regulators by undertaking an independent cost-benefit analysis and technical study alongside other benefits such as enhancements to competition and administrative savings.

Impact Assessment

28. Is the impact assessment of the costs and benefits credible and balanced?

29. Might there be any other unintended consequences which have not been considered?

68. We are concerned that the word “consumers” in the impact assessment is used to represent retail consumers as well as small/large businesses and investment banking customers. This could lead to misunderstanding that all of the costs of the White Paper reforms will be passed on to UK retail consumers. This will not be the case as the majority of the costs will fall on customers of banks outside the ring-fence—mainly large corporations and other financial institutions. These sophisticated purchasers should be perfectly able to shop around and to reduce the extent to which they absorb any increase in costs. Furthermore, a significant proportion of the customers of non-ringfenced banks will be located outside the UK. The Government should amend the impact assessment to make these points clear.

International issues

Compatibility with WTO rules

69. Which? supports restrictions on ring-fenced banks’ activities outside the EEA. However, we are concerned that large banking groups may use the WTO rules to challenge this restriction. The Government should ensure that the proposed restrictions will not be caught by the WTO rules and also lobby for the rules to be changed.12 To ensure that the UK is not challenged in the WTO, the Government should support Ecuador’s proposal for a review of the WTO’s financial services rules.

30. What will be the impact of the proposals on the international competitiveness of UK banks?

70. London’s position as a financial centre needs to derive from its comparative advantage, skilled workforce and infrastructure and not because it is in receipt of implicit or explicit subsidy from the UK taxpayer. Our only hope of hosting a large international banking sector in the UK is to ensure that it does not rely on the taxpayer for support—otherwise we will have to shrink the overall size of the sector. Iceland and Ireland are illustrative of the significant dangers to the national fiscal position of encouraging a significantly over-sized financial sector which ultimately relies on extensive support from the taxpayer. The potential negative impacts on the economy and consumers are increased if banks are able to intertwine essential UK-based activity with international activity.

71. Furthermore, the best way to ensure the international competitiveness of the UK financial sector is to ensure that it faces the full rigour of a domestic and international market with a high level of competition. Any attempts to reduce the level of competition or using government subsidy to insulate certain banks within the UK sector from market discipline are as doomed to failure as policies which attempted to create national champions in other sectors such as the automotive industry or airlines.

31. Are the proposals consistent with existing and forthcoming international and EU regulatory initiatives, for example the recent Liikanen Report? To what extent are they likely to be superseded or generate conflicts?

72. With regard to the design of the UK retail ring-fence we would be concerned if UK retail banks could avoid measures to make UK retail banking more stable by transferring ownership to an entity elsewhere in the EEA and using the “branch” model to offer services to UK consumers.

31 October 2012

1 The full report is available at

2 HM Treasury, Sound banking, Delivering reform, Para 2.9.

3 Please see Para 58 of the Which? submission to the PCBS for further details about the special features of the market for banking services.

4 Draft Financial Services (Banking Reform) Bill, page 8.

5 Conference Call, October 2010,

6 Which? magazine, ‘Keep your money safe’, December 2008.

7 Consumer awareness of the Financial Services Compensation Scheme, FSA, January 2009.

8 We note that this strengthens the arguments for further restructuring of Lloyds Banking Group.

9 For a case study concerning the experience with RBS please see page 59 of the Future of Banking Commission report.

10 For example see


12 WTO, General Agreement on Trade in Services, Article XXIX, Annex on Financial Services.

Prepared 2nd January 2013