As the search for the best supervision and regulation approaches continues, it is essential for the involved countries to conduct thorough assignments on the fundamental principles to employ in order to attain financial system stability and growth (Barth et. al. 2004, p.208). This paper looks into two banking regulation approaches, which are the ring-fencing and total separation strategies.
Approaches to banking regulation
Ring-fencing is a strategy that structurally distinguishes retail banking activities from wholesale and investment bank activities. Ring-fencing mainly focuses on ensuring that provision of services is not interfered with in case of a bank’s failure. Secondly, ring-fencing aims at making it easier and less costly in resolving banks. Thirdly, this approach controls incentives for excessive risk-taking. Apart from the three main objectives of ring-fencing, this approach offers several benefits such as insulating vital UK retail bank services from global financial crises, it allows for an easier monitoring of banks under ring-fencing and in a much transparent way. The other possible benefit is the ability to promote competitiveness because UK retail banking can be made safer (Bertsch 2012, p.2).
The ring-fencing approach offers a number of advantages compared to the total separation approach of bank regulation. To begin with, ring-fencing has the potential to preserve diversification benefits because it allows for an efficient use of capital, and probably lower funding costs. The second advantage is that the ring-fencing strategy preserves a higher degree of operational synergies. Thirdly, ring-fencing approach offers the advantage of having reduced legal obstacles in comparison to full separation. In addition, ring-fencing approach can be implemented with the existing European Union framework, which includes foreign banks within UK subsidiary (Independent Commission on Banking 2011, p.35). In 2011, the independent commission on banking recommended retail ring-fencing of UK banks over total separation. The main aim was to isolate banking activities in areas where continuous provision of services is of the essence to the economy and customers at large. Settling on ring-fencing approach would create a scenario of mutual advantageous interaction between various bank operations, which produces a higher effect than when the operations are carried individually (Independent Commission on Banking 2011, p39). Ring-fencing bank regulatory approach offers a number of restrictions to ring-fenced banks. The first restriction is that banks are not permitted to render services that are not offered to customers within the EEA. The other restriction prohibits such banks from offering services that lead to an exposure to a non-ring-fenced banking institution or non-banking financial organization. Moreover, ring-fenced banks are not allowed to offer services that would lead to trading book asset such as investing in stock, and corporate debt securities. Apart from these restrictions, under this regulatory approach, they are restricted from offering services that would influence the necessity to hold regulatory capital against counter-party credit risk or market risk. These risks include the purchase or origination of derivatives. Finally, ring-fenced banks are prohibited from offering services that relate to the secondary market activity (Singh 2007, p.178). In ring-fencing