Independent Commission on Banking reforms and Basel III - Essay Example

 Independent Commission on Banking reforms and Basel III Independent Commission on Banking Reforms Introduction The ICB (Independent Commission on Banking) released its report highlighting the reforms in 2011 to the United Kingdom banking sector. The discussion for banking reforms is not easy to avoid. United Kingdom has a stable financial service sector with assets dwarf GDP that has a factor of 4.5. The government entrusted the Independent Commission on banking to come up with recommendations to ensure maintenance of the financial service industry and at the same time reducing the risks that the taxpayer in United Kingdom will be required to fund other banks’ bail out (Great Britain, 2012). The recommendations highlighted to improve the United Kingdom banks’ Stability include structural reforms for banks; United Kingdom banks’ retail operations are to be separated from the banking operations that are considered riskier investments (Walker, 2011). In addition, it recommended that there be increased capital for the largest banks to have the capacity to absorb a loss. Lastly, there is a measure to increase competition by influencing the sale branches of Lloyds Banks. The banks have since lobbied hard against these proposals and got the support of the Chancellor to allocate more time to implement the reforms (Grauwe, 2008). These reforms were far beyond the international agreement referred to as Basel 3. Discussion Basel III contain set of reforms that were developed by the Basel Committee created for banking supervision so as to strengthen supervision, regulation and management of risk in the banking sector (Angelini, 2011). Basel 3 aims to discover the ability of the banking sector to absorb shock that is experienced from economic and financial stress and improve governance and risk management. In addition, the reform measures aim to strengthen the banks disclosures and transparency. These reforms targeted the micro-prudential or rather bank level regulation that is entrusted with raising the resilience of personal banking institutions to stress periods. In addition, Basel 3 targets the micro-prudential institution risk that can be experienced across the banking sector and amplification of those risks over time. Basel 3 analyzes it objectives into three essential parts that include capital reform, liquidity reform and other elements that are related to the financial system (Angelini, 2011). The capital reforms include quantity and quality of capital, leverage ratio, introduction of buffers for a capital observation, complete risk coverage and a counter-cyclical capital buffer. The liquidity reforms include the long (Net Stable Funding ratio) and short-term (Liquidity Coverage ratio) ratios. The independent Commission on Banking, on the other hand, came out with a final report that contained their recommendation on the reforms to promote competition and stability in the banking sector in United Kingdom. The recommendations aim to reduce the impact of crises in the financial system for now and future (Adwati & Hellwig, 2013). In addition, maintain a constant flow of credit within the economy and ability of businesses and households to control their risks and needs related to finances. The Commission, in their final report, included seven key recommendations that seem to crash with the recommendations and reforms of Basel 3. The commission categorically states that it is against the idea of separation between the wholesale and retail and investment banking. It claims that the retail activities should be performed in separate subsidiaries that are economically, legally and operationally separate from the entire banking group that they belong to. Second, they recommend that the services related to Domestic retail banking should ne ring fenced and the investment banking and global wholesale outside. This is to ensure that the provisions of banking services that are straightforward to the large domestic companies that are non-financial are in or out. Most of the banks in the United Kingdom are within the retail ring-fence (Labrosse & Olivares, 2011). The third recommendation by the commission suggests that the large retail banks in UK should have an equity capital of not less than ten percent of the risk-weighted assets so as to realize risk absorbency (Great Britain, 2012). This exceeds the minimum requirement recommended by Basel 3. Fourth, the commission recommends that the way to improve the prospects for retail banking competition is to create a new challenger using the Lloyds divestiture. Hence, the government should come to an agreement with Lloyds to make sure that the Lloyds divestiture comes up with a strong challenger bank (Adwati & Hellwig, 2013). To improve accounts’ switching, the commission recommends that a free redirection of service should be introduced for SME and personal current accounts. The commission further suggests that to improve the transparency of accounts by making the currents accounts east to comparable and make it a requirement by the banks to disclose adequate information regarding prices. Lastly, it recommends the abandonment of referral of any banking markets to the competition commission currently unless the requirements are not reached by next year (Great Britain, 2012). In line with Basel three, the commission suggests that since there is additional capital that will be required by the proposed reforms, the loss and structural absorbency elements can wait until the start of 2019. The government seconds recommendation by the Independent Commission on Banking that the vital banking services, retail deposits to be specific, should have access to ring-fenced banks and they should be prohibited from engaging in various banking activities. There is a need for structural reforms in the banking sector (Lewis, 2011). The government in addition, intends that mandated services related to the ring-fenced banks should be introduced that consist of SME and retail overdrafts and deposits (Great Britain, 2011). Sets of investment and wholesale banking services should be done away with. This is important to realize the policy objectives. The government also supports the principles by stating that the ring-fenced bank should have the freedom to conduct ancillary activities in support of the provision of their functions. On loss absorbency, the government seconds the recommendation by the independent Commission on Banking since it is important in making banks able to absorb losses and curb excessive risk taking (Great Britain, 2011). Basel 3 framework is observed by the United Kingdom Banks and has created controversies for its requirement to control liquidity risk (Loader, 2007). Under the Basel 3, institutions linked to banking are required to ensure that their reserve capital is triple to at least seven percent by 2019. This is to act as buffer increase of potential losses that may be experienced if there is a banking crisis globally. In Basel 3, the sixteenth principle, states that the banking regulator will come up with appropriate and prudent requirements for banks that highlights the type of risks recommendable for the banks in relation to markets and macroeconomic conditions within its vicinity. The volatility of the profits by Banks is a significant determinant of its failure risk. These reforms entail a number of risks, which is inherent in any economic activity. Introducing ring-fenced banking system will probably alter the balance of likely shocks that the retail banks are susceptible to in United Kingdom. The ability to bring together different kinds of activities related to banking may have diversified benefits since it can reduce individual bank riskiness in the industry. The commission at one point welcomes the recent move by the Basel 3 reforms to increase the loss-absorbency of bank liabilities (Loader, 2007). If implemented, these reforms will have the added advantage to the banks common equity capital ratios by several times. The ICB highlights a proposal whose objective is to increase the equity ratios of the United Kingdom banks that are ring fenced by not less than ten percent RWAs. Conclusion As analyzed in this essay, it is evident that the reforms by the independent Commission on Banking for the United Kingdom Banking System are way beyond the Basel 3 in various aspects. In addition, there are some reforms that the Independent Commission on Banking has absorbed that are in the Basel 3. The Independent Commission on Banking report is a detailed proposal for retail ring-fenced banks in UK that are to be implemented without total separation of the retail and wholesale banking operations, but through structural reforms. Basel 3 aims to discover the ability of the banking sector to absorb shock that is experienced from economic and financial stress and improve governance and risk management. In addition, the reform measures aim to strengthen the banks disclosures and transparency. Basel 3 is also used by other countries such as the United States. The Independent Commission of Banking in United Kingdom is more complex as compared to the Basel 3 but has a timeline of up to 2019. References Admati, A. R., & Hellwig, M. F. (2013). The bankers' new clothes: what's wrong with banking and what to do about it. Princeton, Princeton University Press. Angelini, P. (2011). BASEL III: long-term impact on economic performance and fluctuations. Basel, Switzerland, Bank for International Settlements, Monetary and Economic Dept. De Grauwe, P. (2008). The banking crisis: causes, consequences and remedies. Brussels, Centre for European Policy Studies. Gola, C., & Roselli, A. (2009). The UK banking system and its regulatory and supervisory framework. Houndmills, Basingstoke, Hampshire, Palgrave Macmillan. Great Britain. (2012). Independent Commission on Banking final report: oral and written evidence. London, Stationery Office. Great Britain. (2011). The Government response to the Independent Commission on Banking. London, Stationery Office. Labrosse, J. R., Olivares-Caminal, R., & Singh, D. (2011). Managing risk in the financial system. Cheltenham, UK, Edward Elgar. Lewis, M. (2011). The big short: inside the doomsday machine. London, Penguin. Loader, D. (2007). Operations risk: managing a key component of operations risk under Basel II. Oxford, Butterworth-Heinemann. Walker, G. (2011). Structural regulation and financial reform: the Independent Commission on Banking. Law and Financial Markets Review , 5(6), 418-434. Read More