‘Ring-fencing’ could hurt bondholders, warns Moody’s

The separation of domestic retail banking operations from riskier activities by Britain’s banks is negative for all bondholders as it puts them in line to suffer losses if the firm hits trouble, analysts at Moody’s said.

Britain is forcing big banks to set up a boundary around their high street operations to protect taxpayers from any problems in riskier investment banking operations.

The so-called “ring-fenced bank” (RFB) needs to be in operation by 2019, and the Bank of England issued a consultation paper on its proposals last week.

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“The proposed changes are credit negative for all bondholders of large UK banks because they remove some key obstacles to the effective resolution of these institutions and the bail-in of their bondholders,” said Carlos Suarez Duarte, a senior analyst at ratings agency Moody’s.

Moody’s said as activities outside the ring-fenced banks will be more volatile and riskier, the credit profiles of those businesses will be weaker.

The standalone credit profiles of the RFBs will benefit from being less risky businesses, but that will make them easier to resolve and enforce losses on creditors, Moody’s said.

The RFBs will also have a high amount of customer deposits, which bondholders rank junior to, which could increase the losses on bondholders in the event of a failure.

Moody’s said the proposed rules had not clarified the treatment of existing creditors of the banks or addressed whether they will become creditors of the RFBs, the businesses outside the ring-fence, or of holding companies.

A review of banks’ financial health led by the European Central Bank can be considered a success before it is completed as banks have raised around 200 billion euros (£157.34bn) in preparation, a top Bundesbank official said.

The results of Europe’s most comprehensive banking review will be released on October 26, giving the clearest picture yet of the state of a sector that was pummelled during the financial crisis.

In anticipation of the results and without knowing how they will do in the tests, European banks have taken steps to strengthen their balance sheets, including raising equity, retaining profit, reducing risk and selling investments.