UK’s SVB resolution advances both sides of the argument on banks' ring fencing

As the UK considers its next steps on bank separation rules, the resolution of Silicon Valley Bank will vindicate those pushing for the regime to stay in its existing form — but will also do the opposite.

On the one hand, the collapse of a mid-sized bank that had to be saved to prevent widespread disruption in the UK’s tech sector advances views that now is not the time for deregulation. On the other hand, UK authorities handled its collapse successfully, without taxpayer input, proving that the resolution regime is doing its job.

The main argument in favor of relaxing the ring-fencing regime — a requirement since January 2019 for lenders operating in the UK with more than 25 billion pounds ($30 billion) in core deposits to separate that retail banking business from the riskier investment bank — is that it was created in advance of the resolution regime. If resolution has effectively superseded ring fencing, then resolvable banks should no longer have to separate their banking businesses.

An independent review that wrapped up a year ago made this formal recommendation and it is now being considered by the UK finance ministry. The idea is that the bank resolution regime prevents lenders from becoming “too big to fail,” which is the same aim of the bank-separation regime, but in theory, more effective as it should entirely prevent taxpayer funds from being used if a bank fails.

When the UK Treasury published a paper setting out its preliminary views on merging the ring-fencing and bank resolution frameworks — a mere two weeks ago — the resolution regime had barely been tested. Some commentators warned that it was too premature to allow resolvable banks to exit the regime, however, warning that while resolution remains untested, it would be foolish to deregulate.

Cue the collapse of Silicon Valley Bank, or SVB. The Bank of England initially declared that the bank had “a limited presence in the UK and no critical functions supporting the financial system,” and moved towards placing it into insolvency. But, after several warnings by the tech sector of an “existential threat” to their industry given the number of, particularly, start-up firms that held accounts with funds above the compensation they would receive via insolvency, resolution was deemed the correct response.

This form of resolution took the private purchaser route, with the BOE and finance ministry brokering a deal for HSBC to buy SVB for the nominal price of one pound, with a temporary exemption for HSBC from certain aspects of the ring-fencing regime to allow the purchase to happen. Being a smaller bank, SVB itself did not have a ring-fenced arm, but the headline outcome from the event is that UK authorities negotiated a successful resolution in what was really their first major attempt to do so.

That will bolster the arguments of those looking to relax the ring-fencing regime: Resolution has now been tested, so bank separation is no longer needed. But the downfall of SVB shows that a bank can still collapse and cause potential risks to an entire sector, in this case, the technology industry, 15 years after the 2008 financial crisis.

Deregulation

For the other side, then, this means any form of deregulation is a bad idea. Industry veteran John Vickers, now a professor of economics at Oxford University, who previously held senior roles at the BOE and drafted a report over a decade ago recommending the introduction of ring fencing, told lawmakers last month that removing the regime would pose a risk to financial stability.

The collapse of SVB and its successful sale to HSBC does not change this, Vickers told MLex: “We definitely do need and should maintain ring fencing for several reasons. One is, in a number of circumstances, it could positively assist resolution. So why give up on that assistance? The other point is that ring-fencing brings benefits that go way beyond the resolution point: there's a degree of insulation, it gives a way to have higher capital buffers for retail banking, and it goes to cultural issues within banks. And there's nothing that's happened in recent days that points in the opposite direction.”

Most people would not have heard of SVB until over the weekend, Vickers added, yet its failure is having effects around the world: “We shouldn't be questioning this fundamental plank of the architecture of UK banking in the way that some would have us do,” he said. “I really do think we should stop entertaining the deregulatory ideas that some would favor; I think this underlines the need for strong regulation of banks. Now, it's true that resolution appears to have worked happily on this occasion. But if the solvency hole had been deeper, who knows, I think we could be in a very different landscape.”

UK lawmakers appear to have similar concerns. In a tweet following the news that HSBC had purchased SVB yesterday, UK Parliament’s cross-party group on banking said the incident shows that “now is not the time for wholesale deregulation. The rules put in place following the last banking crisis are there for a reason.”

Government ministers insist deregulation is not on the agenda, but that the UK is now making rules more relevant for its vast financial services sector following Brexit. Still, there are some signs of it.

While the finance ministry has only set out its preliminary thinking on potential changes to the ring-fencing regime, changes to the regulation of other sectors are much more developed. That's most notable in the insurance industry, where the government ignored calls from the BOE to tighten insurance capital requirements. The central bank has since warned this could lead to a 20 percent increase in insurance failures.

Here lawmakers appear concerned as well. The Parliament’s Treasury Committee has repeatedly questioned senior BOE officials on the chance of increased risks, and lawmakers will have to approve any change in policy before it becomes law.

Parliament is also in the process of finalizing discussions on the Financial Services and Markets Bill, a wide-ranging draft law that gives UK regulators more powers to directly write financial rules following Brexit, but also puts in place several accountability measures, including that they promote the competitiveness of the UK in their rulemaking.

Last month, perhaps unconventionally, junior financial services minister Andrew Griffith asked the industry to help the government define the metrics against which regulators should be measured in achieving this new competitiveness objective.

So, even if deregulation isn’t on the agenda, a change in rules and rulemaking certainly is. How far that will go depends on which side of the argument the events of recent days will most successfully land.