Archegos is a warning shot for UK’s bank ringfencing review

It seems inauspicious timing — if you’re a UK bank. 

Just as a panel of illustrious names prepares to launch its review of a UK regulatory response to the financial crisis, along comes a multibillion-dollar snafu in the world of global banking to provide some context to the discussion.

The regulatory snare in question is ringfencing, enacted against vociferous industry opposition in 2013 to separate the deposit-taking activities of UK retail banks from whatever racy endeavours were happening in the world of investment banking.

And the snafu is, of course, Archegos Capital Management, whereby banks led by Credit Suisse and Nomura, and joined last week by Morgan Stanley, have racked up considerable losses from seemingly outsized and inadequately-managed exposures to the family office in their prime brokerage divisions.

The review — which is due to kick off in earnest this week — is expected to last for a year. A multibillion blotch on the risk management record of the global banking sector, though, merely adds to a sense in the industry that ringfencing is here to stay.

One reason is that the Treasury-led review is a legislative requirement, rather than motivated by any particular desire for change. Ringfencing has a band of vigorous and committed defenders, who back both the principle of separating UK retail business from investment and international banking and the details such as the £25bn deposit threshold above which separation is a requirement.

Another reason is that the policy hasn’t really been tested. Ringfencing’s critics argue that it is conceptually flawed: diversified, universal banks are more sturdy than narrow, focused ones and the logic of separation only holds if a government, in reality, would leave operations outside the ringfence to fail. John Thanassoulis, at Warwick Business School, is doubtful: he is researching whether these pure-play UK banks are really seen as less risky in the eyes of counterparties.

But the ringfence was designed to give the UK government options in a crisis, beyond bailing out a bank wholesale. That hasn’t yet been tested under fire. And the mysterious ability of the world’s investment banks to lose huge amounts of money on one client, in a way that shouldn’t logically be possible, doesn’t instil confidence in doing without it. “We don’t want high street retail banking exposed to this kind of risk,” noted one person.

One potential change would be to the £25bn threshold, given that Goldman Sachs’ Marcus has bumped up against the limit and the launch of a JPMorgan Chase retail product later this year. The cap is, in fairness, a pretty arbitrary number. The speed at which Goldman maxed out, and had to pull back from growth, suggests a lack of competition for the nation’s funds that means savers are getting a raw deal.

Allowing more retail deposits to fund investment banking activities would require careful justification. But a cap that has clearer logic behind it, and that can evolve with the market over time, would be a useful outcome.

There are also valid questions around how ringfencing has operated in practice. Improved focus and governance for UK units has been one advantage. But some argue “trapped” retail deposits have contributed to a price war that has pushed mortgage spreads sharply lower since 2010, forcing smaller competitors from the market.

Cheap mortgages seem unlikely to be the death of ringfencing — especially as research from the Bank of England suggested that ringfencing accounted for perhaps a tenth of the fall in spreads. 

But it is notable that flexibility in the rules designed to prevent deposits being left stranded from lending opportunities hasn’t been well used. For reasons of cost or operational simplicity, most ringfenced banks have stayed relatively “pure” even though activities such as larger corporate lending, trade finance and simple hedging or derivatives could sit on either side of the divide.

Even some ringfencing evangelists concede there could be change here that doesn’t hack away at the fundamental principle of separation. Reform rather than repeal seems the best outcome for the banks — but it would help if their peers stopped losing vast sums in supposedly straightforward lines of business in the meantime.


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