Risk and Regulation Report: Ring-Fencing and UK Banking System

This report provides a comprehensive analysis of the UK banking regulation concerning ring-fencing. It begins by outlining the background and rationale behind the ring-fencing policy, which mandates the separation of core banking services from investment banking activities to safeguard retail banking operations in case of financial instability. The report delves into the specific regulations, including the role of the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA), and examines the limitations of ring-fencing, such as increased operational costs and potential challenges for customers. The second part of the report presents a case study focusing on The Royal Bank of Scotland (RBS), detailing its implementation of the ring-fencing policy, the restructuring required, and the implications for its customers. The report highlights the challenges faced by RBS and the broader banking sector in adapting to these regulatory changes, providing valuable insights into the practical impacts of ring-fencing on the UK banking system.

Running head: RISK AND REGULATION
Risk and Regulation
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Table of Contents
Introduction................................................................................................................................2
Part 1..........................................................................................................................................2
Part 2:.........................................................................................................................................7
Conclusion................................................................................................................................14
Reference..................................................................................................................................15

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Introduction
The main aim of the report is to analyse and research the UK banking regulation rule
of ring fencing. The report discusses the new regulation and the background of the regulation.
The limitations of the new regulations are also discussed in the report. In the second part of
the report an UK bank RSB is selected to analyse the implementation of the ring fencing
policy.
Part 1
An act was passed by the legislation in United Kingdom that it will be mandatory for
large UK banks to separate their core banking services from their investment banking
services on and from 1st January 2019. This process of separating the core banking services
and the investment banking services apart from each other is termed as Ring-Fencing (Cullen
2017). Independent Commission on Banking under the chairmanship of Sir John Vickers
recommended ring-fencing through the Financial Services (Banking Reform) Act 2013.
Supplementary legislation which were passes later in the year 2014, 2015 and in 2016
provides the details regarding the system of ring-fencing. The Prudential Regulation
Authority (PRA) along with Financial Conduct Authority (FCA) also set out rules and
regulations for ring fencing.
Ring fencing is considered as a completely new strategy of the Bank of England in
order to shape up the largest UK banks. The main aim of the regulators is to split up the
services of retail bank through branch, online from that of the investment banking and larger
bank’s global operations. This is ensure that the business’s vital portion will be in safe area
which will not affect the normal people’s working operation in case of any failure caused in
investment banking sector (Wilmarth 2014). In other words, the regulatory authority
described that in case if the banking system crashes then due to the implementations of new
regulation it will be possible to keep running the retail banking services.

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The working process of risk-fenced banks have been clearly stated under several
legislations. This operation includes:
 The risk-fenced banks have been ordered to ensure that they must not be too reliant
for revenue on their investment bank.
 Risk-fenced banks must maintain a separate legal, risk and Human Resource
operations and department of their own.
 These banks must ensure their own independent access to the system of payments at
the top and shall maintain extra capital buffers of considerable amount.
A certain number of international and domestic improvements in banking regulations are
introduced or currently under process due to the severe financial crisis that occurred earlier.
While most of these changes are taken up in order to improve the resolvability of the banks
and others are made to take care of the resilience. Under the Financial Services and Market
Act 2000 amended by the Financial Service Act 2013, in the UK Prudential Regulation
Authority (PRA) is required to make any changes to the rules or to implement the ring-
fencing of core UK services related to finance (Masciandaro and Suardi 2014). This
legislation of ring fencing is only applicable to the large banks of UK with an average of 3
year of business and core deposits amount exceeding £25 Billion. This legislation was passed
so that in case of any financial crisis or failure, the normal and essential banking activities do
not get hampered. Essential banking activities are those core banking services that a bank
provides to its regular or normal customer which includes:
 Acceptance of deposits from customers,
 Making payment into a customer’s account,
 Providing facilities of withdrawing money,
 Enabling to make payments from an account of the customer,

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 Facilities related to overdraft services.
In UK large banks are made compulsory to follow ring fencing so that they can create
asset protection schemes in relation to monetary arrangements, separation due to taxation
purpose and also due to regulatory obligations.
When a part of the company’s assets are separated financially without using it as a
separate entity then the process is said as ring-fencing. The above mentioned reasons for ring-
fencing are discussed below.
Protection of Assets:
The process of ring fencing can be engaged by separating certain assets and liabilities
into different companies of a group is called an arrangement of asset protection. This assists
in improving the credit rating of corporate and also moderating the risk of liquidation.
Separation for the purpose of Taxation:
The major portion of the ring fence profit originate from earnings and gains of the
activities related to extraction of oils in the United Kingdom which are subject to very high
rates of corporate taxation. Through the ring fencing method, it will be possible to treat these
stream of incomes and gain separately so that the tax are also charged in a separate manner as
well which will in turn help in avoidance of any possible confusions.
Apart from these the other crucial reasons for implementation of ring-fencing are:
 Bail out of banks will be less likely to them in case of the new regulations. This is
because of the fact that the investment branches that are applied with a large variety
of financial derivatives is more risky than the retail banking operations. Thus there
will be less chances for the banks to bail out. And if it so happens then it will cost
very less to the banks (Cerutti and Schmieder 2014).

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 Second of all, there are certain motives prevailing in the market which are of moral
hazard for the banks. The banks can rely on bailout from the taxpayer in case if they
take risk such as investing in sub-prime loans and subsequently if it fails. Thus the
banks have the incentives before them to escape or avoid taking risk as this new
system will permit the investment division of the baking system to fail.
Despite of having so many advantages, the ring-fencing regulation have some limitations as
well. Some of the major limitations of the regulation are listed below.
1. Firstly, the cost of operations of the banks is likely to be increase due to
implementation of the new regulations. Thus the introduction of ring fencing
legislation will impose an impact on the bank’s retail deposits to support other
business related investments and mortgages (Hardie and Macartney 2016). As per
estimations it was found that each and every banks that will implement ring fencing
regulations will have to bear expenses close to £200 million. Not only this the lending
capacities of the bank will also be restricted to certain limits as a result of the high
implementation cost and increase in the amount of capital buffer.
2. Second of all, through the implantation of the ring fencing method, the customers are
likely to lose their advantages of having a one-stop-shop of banking service access for
their every needs.
3. Further, it might be possible that the capital funding cost of banks tends to increase as
a result of implementation of ring fencing. This cost shall be increase to such extent as
required by the regulation which shall be met by every part on a standalone basis of
the bank.

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4. The ring-fencing reforms will make the banks imposed to higher competition and
greater challenges as a result of increase in the cost on one hand and limited or small
number of participants on the other. This means that the greater number of UK’s
domestic bank that will not be subject to ring-fencing regulation will enjoy certain
advantages over the ones that are compelled to implement ring-fencing (Glynos et al.
2015). Thus the ring-fenced banks will face several challenges and disadvantages in
general. This process thus can also be termed as biased as it partially favours small
and medium sized banks.
5. The fact whether the implementation of the ring fencing regulation will assist or
support the banks in the situation of any crisis or not is not clear. Further, it might be
possible that ring fencing might make situation more complicate during any such
crisis.
6. It is also observed on a wider scale that several banks might aside their activities
related to higher risk into an arena of shadow banking where there exist no such
regulation or very negligible regulations (if any) due to the implementation of ring
fencing. This might have a systemic impact over the entire banking systems and its
activities or services (Hüttl and Schoenmaker 2016).
7. As far as the current inter-connectedness of the operations and activities of the banks
are concerned, there involves a long period of risk in the implementation of the
required changes in the structure of the bank and resources that are necessary.
8. There are some potential possibility of fraudulent activities to occur during the period
of early implementation of the ring-fencing rules. There are few industry wide
concerns observed regarding the fraud (Zaring 2014). As the banks needs to move the
accounts of their customers from one entity to the other, thus in this entire process the
customer sort code will be changes. In some instants the account numbers might also

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get changed. Therefore there are some considerable possibilities of fraud to occur.
The fraudster will try to impersonate bank and contact customers through emails with
the intentions of diverting payments to rob them. However the PRA and FCA are
working well to minimize the risk as far as possible upon implementation of the new
regulation, but still it is one of the major customer’s security issue that continues to
remain in the new process of ring-fencing.
Part 2:
In this case study, The Royal Bank of Scotland (RBS) have been taken into
considerations to discuss how the large banks in UK are preparing to implementing the ring-
fencing regulations and what are its impact over the customers. It will be also discussed that
what are the major challenges that the bank have faced and most importantly what it means to
the bank and to their customers.
The Royal Bank of Scotland was founded in the year 1727 in Edinburgh and
eventually it went on to be the largest bank in the entire Scotland. Having core deposits
amount more than £25 Billion, RBS needs to comply with the new regulation of UK which is
ring-fencing. RBS described ring fencing as one of the key element of UK Government’s
legal schedule that will bring improvements in its financial stability (Bell and Hindmoor
2014).
Implementation of Ring-fencing by RBS:
In order to apply the new regulation of ring-fencing, RBS will be required to alter the
entire structure of the RBS Group which is not only a complicated and tough job but it will

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also take a quite long period to accomplish. RBS ensures its customer that the bank will be
offering from within the ring-fence a wide and broad range products and services.
RBS states that the existing RBS plc will be renamed as NatWest Market Plc which
will be one of those entities that will offer product which sits outside the ring-fence. RBS also
mentioned that some of its existing valuable customers will be transferred to Adam &
Company Plc from The Royal Bank of Scotland Plc which will take place through the
process known as Ring-Fencing Transfer Scheme (RFTS).
The bank states that during the transfer which will take place during the first quarter
or half of the year 2018, the bank will again rename the legal entity from Adam and
Company Plc to the Royal Bank of Scotland Plc. Therefore as a result of this all the accounts
will continue to be with the banks itself which will be known as Royal Bank of Scotland Plc
and also there will be no changes in the data or details of the bank accounts (D'Hulster and
Ötker-Robe 2015). Every services and personnel including services online banking, debit or
credit cards, relationship managers will remain unchanged. It was also stated that the brand
Adam & Company along with its activities will also remain the same.
RBS provided a timeline which describes how the bank is planning to implement the Ring-
fencing regulation in a smooth manner so that their occur no confusions or error in the entire
process.
 During October to December 2016, it launched the NatWest Market Brand.
 From January to March 2017 under the ownership of RBS Plc, ring-fenced subgroup
was created.
 Again the Western European NatWest branches were opened for business during
April to June 2017.

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 During July to September 2017 was RBS international London Branch target opening
date.
 Ring-fenced Transfer Scheme (RFTS) first court hearing was proposed during
October to December 2017.
 Final court hearing for RFTS was planned during January to March 2018.
 During April to June 2018, execution of RFTS is supposed to take place.
 During the period starting from July 2018 to September 2018, NatWest Market Plc
will be separated from bank subgroup legally and during this period the entirely ring-
fenced bank legal entity structure is supposed to be completed.
 Finally on and from 1st January 2019, the ring-fencing legislation complemented by
the regulatory rules are due to come into action as per the guidelines laid down by
PRA and FCA.

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What this means for the Customers of RBS?
According to the information provided by RBS it was found that almost every
customer of RBS will continue to bank with the ring-fenced banks while keeping their
existing accounts, products and services which are used by them today. In case of any

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changes or difference in accounts or services, the bank will provide the customer with full
support in explaining the changes that might occur due to new regulations.
1. Changes to RBS Customers:
The majority of the banking of customers of RBS Plc will be transferred to Adam &
Company Plc. Again the name will be changed to The Royal Bank of Scotland.
Therefore this process involves a change in the legal entity thus there would be no
such major changes in the either details of the bank account such as account numbers,
banking cards or online banking services. Everything will remain same as before
(Admati and Hellwig 2014).
2. Changes to NatWest Customers:
In case of a NatWest customer there will be no such significant changes as far as the
regular or day-to-day banking activities are concerned.
3. Changes to Complex Derivative Customers:
Complex derivative are not allowed inside the ring-fencing regulations thus the
customers who are associated with such products will continue to retain with RBS plc
and will get transferred to NatWest Market pls with the passage of time.
4. Changes to Fund Customers:
The customers of RBS in respect to fund will be asked to separate their banking
services with RBS International that is the fund center of pure brilliance.

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5. Changes to NatWest Market Customers:
There are no any or major changes as far as the services of the NatWest Markets are
concerned. It will continue to provide services like risk management, financial
solution, trading solutions to its customers from outside the ring fenced legislation
(Masciandaro and Suardi 2014).
6. Changes to Relevant Financial Institution (RFIs) Customers:
As far as the RFIs are concerned, RBS International or NatWest Market will provide
the products that are not allowed to be kept inside the ring-fence such as lending to
those small numbers of customer that exist as Relevant Financial Institution
Customers.
Challenges faced by the bank
The Royal bank of Scotland has announced the implementation of the Ring fencing
within the deadline of 1 January 2019 as set by the UK Government. In order to comply with
the regulation the bank has decided to rebrand its customer facing operations. This
restructuring will ensure that the banks fulfills the legislative requirements of UK that needs
to separate personal banking from the casino banking (Griffiths and Lucas 2016). The attempt
to rebrand has tarnished the brand image of the bank by continuous losses and the slashing of
jobs. The bank because of the restructuring had to pay billions as fine for misconduct. The
bank has also raised certain challenges due to the implementation of the Ring fencing rule.
The implementation of this regulation is a complex task. In addition to this, there are
no clear-cut distinction between the ring fence and non-ring fence activities of a bank. In

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order to ascertain the distinction there are no single test that can be applied. The banks are
using certain parameters to make the distinction for example:
 Timing: the investments that is matured within the 2021 and transaction that are
complete within 2019 can remain within the ring fenced banks;
 Geography: It is clearly if no activities related to non-European Economic Area
(EEA) should be included within the ring-fenced banks.
 Products: The products that deals with investments are not included with in the ring-
fenced banks. That means only the simple derivative products should remain as ring-
fenced banks.
The key challenges that the banks faces in the implementation of the changes in order to
comply with the regulation is the successful separation of delivery with the projects within
the delivery dates. The banks have already started the implementation of the ring fencing
change programme (Haas and Lelyveld 2014). This has become evident that there are certain
overlaps within the existing programme of regulatory change. The implementation of the
changes often involves a lot of rework that has to be performed. The lack of strategy and
framework has put the bank in a lot of pressure on the delivery.
The changes in new regulation brings certain individual bank level challenges that
are:
 Cost: The estimated cost for implementing the banking reform of ring fencing is 200
million.
 Customer impact: The implantation process is likely to cause disruption in the
delivery of service affecting the customer. The bank is required to evolve strategy to
address this challenge immediately.

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 Capacity of lending: The increase in the buffer money and the cost of implementing
the new strategy can result in the decrease in the fund of lending.
Industry specific challenge
The new regulation of ring fencing also significantly affects the banking industry as a
whole. The banks are moving the accounts between the entities as a result the customer code
and the account numbers are likely to change affecting the service of the entire banking
sector. This has increased the risk of fraud as the fraudster can impersonate a bank mail and
take important details from customers (Binder 2014). The two agencies PRA and FCA are
closely monitoring the communication between the banks and the customers are within the
secured channels. However, it can be said that the significant risk to the banking industry still
exists. Therefore, based on the above discussion it can be clearly said that the structural
reform is an important challenge to the UK banking sector.
Conclusion
The report was aimed to analyze the implementation of the new regulation of ring
fencing. The above discussion shows that there are certain advantages and limitation in the
implementation of the new regulations. The RSB has is also implementing the ring fencing
and it is facing certain challenges.

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