About Innovate Finance

Innovate Finance is the independent industry body that represents and advances the global FinTech community in the UK. Innovate Finance’s mission is to accelerate the UK's leading role in the financial services sector by directly supporting the next generation of technology-led innovators.

The UK FinTech sector covers businesses from seed-stage start-ups to global financial institutions who embrace digital solutions, playing a critical role in technological change across the financial services industry. FinTech has grown strongly since the Global Financial Crisis of 2007/8, which led to mistrust in traditional banks and coincided with an explosion in the use of smartphones, widespread adoption of the use of apps, the advent of blockchain technology, and significant investment in FinTech start-ups.

FinTech is synonymous with delivering transparency, innovation and inclusivity to financial services. As well as creating new businesses and new jobs, it has fundamentally improved the ways in which consumers and businesses, especially small and medium sized enterprises (SMEs), access financial services.

1. Introduction

Innovate Finance welcomes the opportunity to respond to HM Treasury’s (HMT) call for evidence on Aligning the ring-fencing and resolution regimes. The views expressed in our paper are the consensus position of digital first, start-up and scale-up challenger banks that do not form part of a holding company or wider organisation structure in the UK or internationally, as well as e-money institutions that are in the process of applying for a banking licence.

1.1 Our members are broadly supportive of efforts to simplify and streamline overlapping regulatory regimes, where this does not impact negatively upon consumer protections, financial stability and market integrity. The way in which various regulatory regimes interact and the inconsistency of thresholds that determine the instances when they apply creates considerable regulatory burden from the perspective of growing challenger banks. This creates compliance risk and makes supervision more difficult, particularly for new market entrants.

1.2 Our members recognise that ring-fencing and resolution are not intended to operate as equivalent regimes as they have different aims. However, our members emphasise that ring-fencing has the complementary objective of making it easier to preserve the orderly continuity of critical banking services in resolution without taxpayers having to bear the costs of banks failing. Bearing this in mind, if the ring-fencing regime is to be significantly altered or removed altogether, our members call on HMT to consider the extent to which the protection that ring-fencing introduced in ensuring retail deposits do not fund activities that expose depositors to unnecessary or inappropriate levels of risk might be retained.

1.3 Given that several components of the regimes that form the regulatory framework are subject to ongoing or forthcoming consultations (such as the implementation of the Basel 3.1 standards and the Senior Managers and Certification Regime (SMCR)), it would be challenging to comment on the individual regimes in isolation. Hence, we recommend that questions on aspects of entity governance may be better addressed in the context of SMCR reform, instead of alignment with the resolution regime.

1.4 Innovate Finance supports HMT’s proposed criteria to better align the ring-fencing and resolution regimes in the long-term, in particular the impact on UK competitiveness and growth, and impact on competition. Challenger banks continue to contribute significantly to the UK economy, and there is concern that the removal of the ring-fencing regime would have unwelcome consequences. Although challenger banks are unlikely to be required to ring-fence their retail bank operations, the existence of the regime has a substantial impact on the wider banking landscape and the way in which challenger banks operate.

1.5 Our challenger bank members also note that the presence of the ring-fence can and does serve to check the expansion of large incumbent or international banks in the current and savings accounts space (though ring-fencing was not introduced as a competition measure). It would therefore be counterproductive if the removal or reform of the regime were to have an adverse effect on competition and jeopardise an increasingly diverse retail banking market. Hence, our members recommend that the competition implications of reforming the ring-fencing regime be considered by HMT before they are implemented, and that if the ring-fence were to be disapplied in some instances, there should be transparency on the circumstances where disapplication is warranted. Clear guidance is also needed on the re-application of the ring-fence after an initial disapplication.

1.6 We present our comments thematically with signposts to questions in the call for evidence where relevant. The themes of our consultation response are as follows:

a) Simplification of regulatory landscape;
b) Conflation of purpose; and
c) Competition.

1.7 We would be happy to discuss these points with you and the role of challenger banks on a bilateral basis, and/or facilitate a roundtable with our challenger bank working group as you refine the details of the UK regime.

2. Simplification of regulatory landscape (Question 5)

2.1 Innovate Finance welcomes an approach that seeks to simplify and/or streamline overlapping regimes and supports the aim of aligning the ring-fencing and resolution regimes where sensible to do so.

2.2 In line with comments Innovate Finance has previously made, the way various regulatory regimes interact and the inconsistency of thresholds that determine their applicability creates a substantial regulatory burden. From a growing challenger bank perspective, navigating these various regimes and understanding the different thresholds that apply within them (which will increase with the introduction of the Strong and Simple regime) has a disproportionate impact on the limited resources of smaller banks.

2.3 Different regulations often involve different teams or departments within a bank. Regulatory complexity creates compliance risk and makes supervision more difficult, particularly for new market entrants. Our members note that this has been acknowledged by the Prudential Regulation Authority (PRA) in its discussion and consultation papers¹ on the Strong and Simple Framework which seeks to mitigate the complexity problem.

2.4 As a result, streamlining/consolidation and alignment of regimes is welcome, where appropriate. However, we make the following observations:

a) Any such simplification/consolidation should be considered in the context of the requirements and thresholds of other regimes and the lead times for competing implementation projects that those regimes impose.

b) HMT should be mindful of introducing additional and “cliff edge” requirements for banks that currently enjoy growth but do not yet anticipate meeting the ring-fence threshold.

c) Consideration should be given to clarifying supervisory expectations of firms for pre-threshold preparations and the timing of the associated supervisory interventions.

d) Consider introducing a grace period for implementing changes after mergers, which can cause thresholds to be crossed instantaneously and at relatively short notice.

e) Consider indexation of thresholds.

3. Conflation of purpose (Questions 1 – 5)

3.1 Innovate Finance also recognises that the ring-fencing and resolution regimes sit within a wider framework of complementary prudential and conduct regulatory regimes (such as Outsourcing, Operational Resilience, capital and liquidity adequacy requirements, minimum requirement for own funds and eligible liabilities (MREL), SMCR, and Operation Continuity in Resolution (OCIR)) that work together to ensure the stability of the services and critical functions of retail banking.

3.2 Each of these regimes work as part of a wider landscape, each aimed at delivering different but often similar policy objectives.

3.3 The policy objectives of this call for evidence are the Bank of England’s (BoE) objectives for resolution, that is positive outcomes for:

a) Protections of public funds;

b)Continuity of banking services and critical functions; and

c)Protections of depositors.

3.4 Ring-fencing and resolution are not intended to operate as equivalent regimes and have different but complementary aims. The former principally seeks to insulate retail banking operations from shocks elsewhere to the financial system; the latter seeks to ensure banks (retail or otherwise) can fail in an orderly manner without requiring taxpayer support.

3.5 However, ring-fencing has the complementary objective of making it easier to preserve the orderly continuity of critical banking services in resolution without injecting taxpayer funds.

3.6 For example, Questions 1 and 2 of HMT’s call for evidence focus on the extent to which ring-fencing might assist in planning for resolution or managing a firm in resolution. Whilst there are elements of the ring-fencing regime that go to these points – these are secondary objectives after insulation.

3.7 HMT should therefore consider the extent to which the protection that ring-fencing introduced in ensuring retail deposits do not fund activities that expose depositors to unnecessary or inappropriate levels of risk might be retained should the regime be significantly altered or removed altogether.

3.8 Several components of the regimes that form the regulatory framework are subject to ongoing or forthcoming consultations (for example, the recent PRA consultation on implementing the Basel 3.1 standards and the HMT call for evidence and the PRA/Financial Conduct Authority (FCA) review on the SMCR). Given that these various regimes operate together to deliver financial stability, market integrity and good customer outcomes, it is therefore difficult to comment on individual regimes in isolation.

3.9 We note, for example, that HMT asks a question around the extent to which ring-fencing facilitates more effective risk management and supervision in Question 3. The ring-fencing regime requires governance of ring-fenced banks (RFBs) to be sufficiently independent and subject to sufficient independent challenge to ensure that decisions are taken by the governing body within an RFB in the interests, and for the benefit, of the RFB. This is of particular relevance where the RFB sits within a wider group structure that may engage in non-ring-fenced bank activities, as one of the key ways of insulating retail banking services from other potentially riskier activities, exposures to the financial system and conflicting management priorities.

3.10 Innovate Finance suggests that questions like these on aspects of entity governance could be better addressed in the context of reforms that are being proposed in relation to the SMCR (which deals with individual accountabilities), rather than in the context of alignment with the resolution regime.

4. Competition (Questions 5, 6, 7 and 9)

4.1 Innovate Finance is supportive of the proposed criteria HMT proposes to use to assess possible options for better aligning the ring fencing and resolution regimes in the long-term (impact on financial stability, impact on firms, impact on UK competitiveness and growth, and impact on competition), especially, the last two.

4.2 Challenger banks make an important contribution to the UK economy by increasing competition in the retail banking space, and providing greater credit to a growing number of SME customers. Fifty-five per cent of SME lending is provided by challenger banks outside the 'big 5' high street banks (based on BoE and British Business Bank data for 2022). This has been crucial for the UK economy as SMEs now constitute approximately 61% private sector employment and roughly half of UK GDP, which has been made possible by the critical role of challenger banks in providing credit to the SME sector.

4.3 Innovate Finance considers the panel of independent experts led by Sir Keith Skeoch (“the Panel”) conclusions on the regime’s impact on competition are incomplete. Whilst the impact of the implementation of ring-fencing on competition within the UK retail banking market, corporate lending and productive finance markets may have been marginal (or non-existent), our members are concerned that its removal or reform would not be.

4.4 Typical challenger banks (which have grown in number since the ring-fencing regime was introduced) are, by definition, unlikely to be required to ring-fence their retail bank operations. However, the existence of the ring-fencing regime has a significant impact on the wider banking landscape and the way the challenger banks operate within it.

4.5 The disapplication of some of the ring-fencing requirements with regard to the recent takeover of Silicon Valley Bank (SVB) demonstrates how the ring-fence regime can operate to prevent large incumbent banks from taking certain actions. While the financial stability considerations warranted this action, the presence of the ring-fence can (and does) serve to check the expansion of large incumbent banks or international banks in the current and saving account space.

4.6 Whilst we acknowledge that ring-fencing was not introduced as a competition measure, our view is that it would be counterproductive if the removal or reform of the regime were to have an adverse effect on competition.

4.7 Reform should not allow market players whose activities are currently restrained by the ring-fencing regime to take advantage of their size to squeeze out smaller banks. The benefits to consumers of an increasingly diverse (and therefore more resilient) retail banking market could be put at risk.

4.8 We would therefore recommend that HMT should evaluate the competitive implications of any reforms to the ring-fencing regime before implementing them.

4.9 If disapplication of the ring-fence in certain circumstances is a preferred route (rather than reform of the regime as a whole), Innovate Finance recommends HMT consider transparency as to the circumstances in which this may occur, both before and after the event (in the latter this could take the form of a public register of instances where the rules have been disapplied with details of such disapplication and the underlying rationale). Our members would also appreciate guidance on the re-application of the ring-fence after an initial disapplication. This will assuage concerns that the ring-fence can be disapplied arbitrarily without set guidance, thereby strengthening the impact ring-fence.

[ENDS]

1 PRA DP1/21 A strong and simple prudential framework for non-systemic banks and building societies

PRA CP5/22 The Strong and Simple Framework: a definition of a Simpler-regime Firm

PRA CP4/23 The Strong and Simple Framework: Liquidity and Disclosure requirements for Simpler-regime Firms