12 September 2011

ICB: Final Report - Recommendations

The Independent Commission on Banking published this Final Report which sets out the Commission's recommendations on reforms to improve stability and competition in UK banking. It builds on the Interim Report, published on 11 April 2011, and responses to its consultation on reform options.

Aims of reform

The recommendations in this report aim to create a more stable and competitive basis for UK banking in the longer term. That means much more than greater resilience against future financial crises and removing risks from banks to the public finances. It also means a banking system that is effective and efficient at providing the basic banking services of safeguarding retail deposits, operating secure payments systems, efficiently channelling savings to productive investments, and managing financial risk. To those ends, there should be vigorous competition among banks to deliver the services required by well-informed customers.

Financial stability

More stable banking requires a combination of measures. Macro-prudential regulation by the new Financial Policy Committee should help curb aggregate financial volatility in the UK. But domestic financial shocks cannot be eliminated. Moreover, the UK remains exposed to international financial volatility, in part through the global operations of UK banks.

Improved supervision by the new Prudential Regulation Authority should avoid some shortcomings of regulation exposed by the recent crisis. But information problems mean that supervisory regulation will never be perfect. In any case, it should not be the role of the state to run banks. In a market economy that is for the private sector disciplined by market forces within a robust regulatory framework.

Therefore a package of measures is needed that:

• makes banks better able to absorb losses;
• makes it easier and less costly to sort out banks that still get into trouble;
• curbs incentives for excessive risk-taking.

The Commission’s view is that the right policy approach for UK banking stability requires both (i) greater capital and other loss-absorbing capacity; and (ii) structural reform.

Competition

There are long-standing competition issues in UK retail banking. On the supply side, core markets are concentrated. On the demand side, competition between banks on current accounts is muted by difficulties of switching between providers and by lack of transparency about banking services on offer.

The ‘too big to fail’ problem gives large banks a competitive advantage over smaller banks which already face differentially high regulatory capital requirements. This last problem is to some extent addressed by the Commission’s financial stability recommendations, including the higher capital requirements on larger banks. Eliminating the implicit government guarantee is pro-competitive. Furthermore, higher capital requirements guard against competition being directed in part towards unduly risky activities, as was the case in the run-up to the crisis when misaligned incentives led banks to ‘compete’ by lowering lending standards. The crisis has at the same time created opportunities to improve competition. The Commission’s aim is to promote effective competition, in which banks compete to serve customers well rather than exploiting lack of customer awareness or poor regulation.

Beyond ICB financial stability proposals, the Commission advanced provisional views:

• that the divestiture of Lloyds’ assets and liabilities required for EU state aid approval will have a limited effect on competition unless it is substantially enhanced;
• that it may be possible to introduce greatly improved means of switching at reasonable cost, and to improve transparency; and
• that the new Financial Conduct Authority (FCA) should have a clear primary duty to promote effective competition.

Full report

© ICB - Independent Commission on Banking