ICB Ringfencing Reforms Likely To Hurt UK Bank Ratings Long Term

Includes: BCS, LYG, RBS
by: Research Recap

Fitch Ratings says in a new report that the UK’s Independent Commission on Banking (ICB) reforms are a major step change for UK banks and goes beyond other resolution regimes being developed.

FitchThe reforms have no immediate rating implications because of the long timeframe for legislation and implementation and the flexibility around certain critical features. However, the reforms will significantly weaken implicit government support for all banks, which is likely to impact ratings longer term.

The ICB’s final recommendations for UK banks to create a retail ring-fence with a minimum common equity Tier 1 (CET1) ratio of 10%, total ‘primary loss-absorbing capital’ equivalent to 17%-20% of risk weighted assets, insured depositor preference and bail-in powers goes further than reforms being discussed in other countries.

A well capitalised ring-fenced bank (RFB) undertaking relatively low-risk banking operations in a better disciplined market should be a safer bank, with more stable ratings through economic and market cycles. Its credit profile should be supported by its retail/SME franchise, generally low risk secured retail lending and limited treasury activities.

The impact for non ring-fenced bank (NRFB) creditors is likely to be broadly negative as any current funding and low risk profile benefits from the retail operations is eliminated or largely diluted (if the NRFB owns the RFB). Negative pressure would be most relevant to Barclays Bank plc (NYSE:BCS) and Royal Bank of Scotland Group plc (NYSE:RBS), if higher-risk investment banking dominates the NRFB’s business mix.

However, Fitch notes that subordination of senior creditors arises from the proposal that insured deposits should be moved above other unsecured creditors. This is likely to be negative for senior debt ratings within the RFB. Fitch is not persuaded by the case for the limiting of depositor preference to only insured deposits.

It is unclear whether bail-in senior debt will become a new asset class, effectively subordinate in resolution/liquidation to existing unsecured creditors, or created through the use of bail-in powers and affect existing senior unsecured debt. Fitch believes talk of “grandfathering” to be fundamentally misplaced.

The potential for reduced government support would be most relevant for Lloyds Banking Group plc (NYSE:LYG) and Royal Bank of Scotland Group plc, whose Issuer Default Ratings (IDR) are at their Support Rating Floors, meaning that any potential reduction in support would exert pressure on their IDRs.