British Banks Likely To Be Broken Up, Not Just Ring-Fenced

It looks like the relief the U.K.-based banks enjoyed since last September – when the ICB report recommended that retail and investment banking operations of British banks be “ring-fenced” rather than completely separated (see ICB Report Gives UK Banks Breathing Room with 2019 Implementation) – was too good to last. The Parliamentary Commission on Banking Standards is apparently looking to push for legislation to make it mandatory for the big banks to break up their businesses. ^[1] If that is indeed the case, then Barclays (NYSE:BCS), RBS Group (NYSE:RBS), HSBC (NYSE:HBC) and Standard Chartered Bank (NASDAQ:STAN) may soon have a much bigger problem on their hands.

We maintain a $9.50 price estimate for RBS’s stock and a $15 price estimate for Barclays’ stock, which are both below their current market prices.

The British Government is Dilly-Dallying Over Its Banking Rules..

Last year, the U.K.’s coalition government entrusted the 5-member Independent Commission on Banking (ICB) with the task of understanding how stable and competitive the country’s financial system was and also charged the ICB with the responsibility for suggesting how to handle the banks that were “too big to fail”. ^[2]

The ICB kicked up a storm early last year with the first draft of its report, which suggested that the country’s largest banks be broken down and their investment banking and retail banking divisions separated. But the ICB took a middle path in its final report, proposing steps to ring-fence various essential retail banking functions of the banks defining what activities should be and should not be permitted inside the ring-fence. Despite the fact that the ring-fence would increase direct operational costs for the banks, it was a better option considering the substantial increases to the cost of capital and funding in case operations were to be separated completely.

And now, well over a year after the ICB passed its verdict, the Parliamentary Commission on Banking Standards is reportedly treading the same path the ICB originally pointed towards, and may call for legislation to split the big four banks. ^[1]

… Leaving The Fate of The Biggest Banks Hanging

The British government’s focus on making the country’s banking system more robust is understandable given that it was forced to bail out RBS and Lloyds during the economic crisis and is yet to see a practical way of recovering its money. The fact that the top six British banks handle about 90% of all deposits is also a pressing reason to put stricter laws in place.

But the solution cannot be extreme as then the policies implemented themselves will undermine the country’s banking system. While the British banks will not find themselves able to compete with competitors headquartered in other countries, their bottom-lines will also receive a significant blow due to additional annual “frictional” costs – estimated at £7 billion ($11 billion) annually – stemming from a separation of the banks’ retail & investment banking functions. After all, the impact the banks expect would have to be really bad for them to actually voice the possibility of shifting their headquarters out of London just to escape the stringent requirement (see Barclays CEO Hints at Shifting Headquarters Out of the UK).

You can see the impact of lower investment banking margins on RBS’s estimated value by making changes to the chart above.

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1. Parliamentary Banking Commission to call for banks to be broken up, rather than just ring-fenced, The Telegraph, Dec 16 2012 [↩] [↩]
2. Independent Commission on Banking (ICB) – UK’s biggest banks should be broken up, Asymptotix, Jan 22 2011 [↩]