Incoming ring-fencing legislation introduced by the Financial Conduct Authority (FCA) requires each large UK bank to separate its retail banking activity from the rest of its business.
This is to protect customers and the day-to-day banking services they rely on from unrelated risks elsewhere in the banking group and shocks affecting the wider financial system.
The FCA says the capital ring-fencing rules are designed to protect the basic services of a parent retail bank:
• Accepting deposits or other payments into an account
• Offering facilities for withdrawing money or making payments from an account
• Overdraft facilities
There is a good argument to make that business finance at the smaller SME end of the market tapers into the retail responsibilities of banks that the ring-fencing regulations are designed to protect.
Leasing is a vital part of the service that a bank or funder offers to the local community. It seems strange that regulatory ring-fencing should force banks to protect retail customers, but at the expense of leasing that services SMEs, which could be owned by those same retail customers.
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The difficulty that many banks with leasing businesses have had over the past few years is determining whether or not their leasing businesses are to be included in the regulatory ring-fence of capital.
Many would argue that there is not a better asset for the balance sheet of a parent bank than a leasing business. They are low risk, produce solid returns, and are based on secured loans on valuable assets. If economic circumstances do actually change and small business clients go to the wall, then there are realisable assets to sell to draw down against the default losses.
From the bank’s point of view, these are fairly safe product lines in the event of a downturn.
Even in boom times, leasing businesses in banks can be surprise packages against traditionally more profitable banking endeavours like investment banking. Earlier this year I learnt that one large global French bank’s leasing business was producing better returns for shareholders than its investment arm.
One example of the conflict that ring-fencing is causing for UK banks concerns RBS.
RBS could offload its Lombard business in the Channel Islands and Gibraltar in order to meet ring-fencing rules, Leasing Life found out in November.
Sources say the decision to sell resulted from the inability to fit Lombard’s offshore portfolio into RBS’s balance sheets under incoming ring-fencing rules.
One source added that transferring Lombard to NatWest Markets, which will not be subject to ring-fencing, was not an option either.
The effect is that no new leasing business is being written by Lombard in those areas, as agents for the sale KPMG seek buyers for the loan books there.
It is a shame that Lombard’s long running Channel Islands business and its customers could be at risk because of regulation designed to protect retail customers.