The ICB recommended that retail operations be “ring-fenced” by 2019. A separate legal entity within a bank’s corporate group is to be established to provide retail and commercial banking services in the UK.
Ring-fencing similar to the ‘swaps push out’ requirement in the U.S., which separates derivatives trading businesses from banking activities. Further, under the Volcker Rule, banks are to be prohibited from proprietary trading as well as investing in or sponsoring hedge funds and private equity funds. The ring-fencing recommendations by the ICB focus on insulating core essential banking services from potential losses caused by other activities, i.e., the riskier activities will otherwise be left intact within a non-retail investment banking structure. The ICB recommendations are only one small step short of a full Glass-Steagal separation of retail and investment banking in calling for operational, economic and legal separation. While this may improve safety of retail banks, it is a paradigm shift for bank structures and will come at a cost. In many respects the recommendations will create a bank model as purposed by Glass-Steagal (before its repeal in 1999): a style of retail banking where it is perceived as more of a basic utility with low return on equity for shareholders.
To comply with the ring-fencing requirements, banks will need to fundamentally overhaul their business models. Essentially banks will need to create another bank within their bank with new boards and systems. This will come at a significant cost and the challenge for banks is to get this right in the first instance, as it will not be easy to undo.
As far as the static efficiency criteria are concerned, based on its pure definition of weighted mean difference ultimate depositors/savers and ultimate users, the ring-fencing will “add” to the mean spread. The current spread, however, may