Should the UK Treasury relax bank ringfencing rules?

The UK Government has announced that it will relax the ringfencing rules which banks have to abide by, though it has resisted pressure from some banks to scrap them altogether. 

The rules were introduced to create a stabler and less risky banking system in the wake of the global financial crisis of 2008 and the subsequent Vickers Report, which was established to suggest potential reforms. 

These required the largest banking groups to separate core retail banking services from investment banking operations, preventing them from freely moving liquidity between subsidiaries.  

The aim was to prevent the deposits from UK consumers being recycled into high-risk businesses, often abroad, resulting in a run on UK banks if disaster strikes. 

If necessary, loss making corporate and investment banking activities can be split off from the UK division to avoid a repeat of the situation at the Royal Bank of Scotland (RBS), where a bank that is simply too big to fail has to be fully bailed out by the government – bond holders and international investors included.  

Those who oppose these ringfencing rules question how effective they have been and whether the costs they create for banks are justified. 

In response to these questions, we set out to explore just how safe the ringfenced banks were in the eyes of professional and informed counterparties.

We realised we could measure this in almost real time using the interest rates in the UK repo market, a financial system that allows institutions to borrow and lend cash for very short periods to ensure daily liquidity.

How to measure risk in the banking sector

Repo transactions, collateralised by UK gilts, are the main way in which dealer banks and financial counterparties share risk and manage their liquidity. The lending is frequent, large, and backed by safe collateral. Therefore, the price that is charged measures just the riskiness of the two participants. 

Comparing this repo price across all ringfenced and non-ringfenced entities gives us a read-out of risk perceptions. 

We found that ringfenced subsidiaries can consistently borrow cash more cheaply than non-ringfenced peers. 

This means third parties, hedge funds, mutual funds, pension funds and insurance companies see a ringfenced subsidiary as safer than an otherwise identical but non-ringfenced subsidiary so they’re willing to lend cash at a lower rate. That is, they will accept a lower interest rate to deposit money there, as opposed to putting it elsewhere.  

There are two reasons why ringfencing may have this effect. One is that ringfenced banks must meet capital and liquidity rules at the subsidiary level. 

This means that in a crisis situation, liquidity can only flow into the bank. It cannot flow out to the wider banking group if that reduces liquidity to below mandated levels. 

The other reason is that ringfencing reduces the complexity seen in large banking groups, making oversight easier and resolution options more credible.  

As well as confirming that any reduction was due to the perceived level of risk, we established that the regulation behind the ringfencing is pivotal.

Why should the bank ringfence be regulated?

In 2018, banks including HSBC and Barclays set up ringfenced entities ahead of the regulation coming in, but this did not result in a ringfence bonus. This only occurred once the law came into effect in January 2019. 

The significance here is that banks were tied to the ringfencing regime; they were unable to move too much liquidity out of the retail bank into another subsidiary whatever happened. 

Put simply, the market didn’t believe that banks would leave money in the retail subsidiary if a crisis hit, unless there was a legally enforced requirement to do so.

This means the regulations work. It creates a much simpler business that takes savings and issues mortgages and loans to small businesses. It makes banks safer. 

That’s not us saying that; other informed counterparties such as pension and insurance funds are telling us that through the amount of money that they demand for lending to them.  

At the same time, we thought lenders may be nervous about those entities which sit outside the ringfence and are explicitly not protected by a government guarantee. This would mean an increase in the rate of interest which they pay to borrow money. However, we saw no such effect. 

What are the benefits of ringfencing banks?

Ringfencing lowers the cost of borrowing at group level as well as for the UK ring-fenced subsidiary. 

One reason for this appears to be that the risk appetite of the subsidiaries outside the ringfence has gone down to counteract the fact that they have now lost a little bit of liquidity insurance. 

They’re moderating their behaviour so that, on balance, they keep borrowing at around the level that they were before ringfencing came in.  

Ringfencing has also created safe haven banks that counterparties prefer to interact with in times of uncertainty or crisis, which creates a benefit to consumers and society as a whole. 

This was seen during the Covid pandemic, when the ringfenced entities were able to borrow particularly cheaply, and informed capital went there. 

We also found that when the ringfenced entity lends cash itself in these overnight repo markets, it charges more, which would be expected when the risk appetite is lower.

But while the system of ringfencing has succeeded in creating safer banks, and making them more attractive to lenders, we are not seeing banks asking to be ringfenced. 

Why do critics want to scrap bank ringfencing rules?

There are costs to ringfencing, as well as benefits. These include the raw costs of dealing with the ringfence, such as hiring people to manage it. 

And while having a more secure financial system is beneficial to the overall economy, it does not necessarily lead to increased profits for the banks themselves. 

In fact, it’s likely that there is an overall reduction in profits for ringfenced banks as they can’t so easily lend to high-risk high-reward projects.

While ringfenced banks are safer, there are alternative models available. For example, The Skeoch Review, published in 2022, suggested a system of resolution under which shareholders and creditors – rather than taxpayers – bear the costs of any failure through a “bail-in” mechanism.  

This is something Switzerland explored but ultimately decided not to implement when Credit Suisse failed in 2023. In this case, resolution alone didn’t work. 

We know ringfencing works in terms of lowering risk. This is particularly important in markets such as the UK, which have a large international banking sector compared to the size of the domestic economy.

What are the risks of changing ringfencing rules?

As such, there are two pieces of bad news in the Treasury’s plans to reform the ringfencing rules. 

The first is the proposal to allow banks to “share operational resources across the ring-fence”. During a crisis, this can only make it more complicated for the Bank of England’s Prudential Regulation Authority to split up a banking group that is in trouble. 

The second comes in the ambiguously worded proposal to allow ringfenced banks to invest in firms which “undertake activities which the ringfencing regime would permit”. 

No doubt these firms will also undertake many activities that would not be permitted under the ringfencing regime. This makes the value of the ringfenced bank’s assets invested in these entities more opaque. 

With the Bank of England due to consult on further changes over the coming months, this poses a crucial question. If we’re not confident that a different system based on bail-in will work in a crisis, why would we dismantle a system which we know does?  

• This article is based on the following study: Erten, I., Neamtu, I., and Thanassoulis, J. (2026) The ring-fencing bonus, Review of Finance Volume 30, Issue 3, Pages 995-1028. doi:10.1093/rof/rfaf076. It was also published as a working paper by the Bank of England in October 2022.

Further reading:

Should the Bank of England have a dual mandate?

Is financial regulation making banking increasingly risky?

Trump vs The Fed: Why central bank independence matters

What does a digital pound mean for commercial banks?

John Thanassoulis is Professor of Financial Economics and Associate Dean for the Bank of England Partnership. He teaches Financial Conduct, Leadership and Ethics on the MSc Global Central Banking and Financial Regulation and Banks and Financial Institutions on the MSc Business and Finance, the MSc Finance, and MSc Finance and Economics. He also teaches Ethics, Financial Regulation and Corporate Governance on the MSc Finance and MSc Finance and Economics.
 
Irem Erten is Assistant Professor of Finance. She teaches Corporate Finance on the Executive MBA, Executive MBA (London), Global Online MBA, and Global Online MBA (London). She also teaches Data Analysis for Finance on the MSc Finance and MSc Finance and Economics, as well as Research Methodology for Financial Management on the MSc Business and Finance.

Develop your career in banking and the financial sector with the MSc Global Central Banking and Financial Regulation, delivered in collaboration with the Bank of England.

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