UK Chancellor of the Exchequer Rachel Reeves has made economic growth her top priority, creating the Growth Mission Board in July 2024 to help spur it along. In October, the UK’s Invest 2035 Modern Industrial Strategy Green Paper, featuring the financial services sector as one of eight growth industries, was also announced. However, without a modest recalibration of some of the rules and regulatory machinery governing the banking industry, the UK economy won’t be able to reach its full potential.
The Role of Banks in Economic Development
The banking industry stands ready to support the growth agenda. To maximize the chances of success, regulators and policymakers play an important part by promoting international competitiveness and ensuring the UK market is an attractive place to invest in and expand financial services. In making modest changes to align UK banks with their international peers, they can help get the flywheel of growth moving faster for everyone — consumers and businesses alike.
In this report, written in collaboration with UK Finance, we show how modest regulatory adjustments — led by government but in a coordinated effort among policymakers, regulators and banks alike — can help rejuvenate the banking industry and drive the UK government’s growth agenda.
Understanding the Banking Ecosystem
Banks play a vital role in economic activity, by providing credit and other services across the economy as well as by attracting businesses and creating jobs. Consumers and businesses use that credit to fund large purchases and investment, which stimulates other businesses. That, in turn, brings more investment to the banking sector, providing still more capital to fund still more economic activity, and on and on in a virtuous circle of growth.
Challenges to Innovation and Growth
However, current conditions constrain innovation and growth. In the past few years it has become increasingly evident that the emphasis on resilience of individual banks and the financial system, as well as consumer protection since the global financial crisis (GFC), is stifling the industry’s growth and rendering it less attractive to investors. UK banks trade at a modest discount to those in the EU, and both badly lag those in the US.
The Balancing Act: Growth vs. Safety
The trade-off between growth and safety is a constant balancing act for policymakers. Lurch too far toward growth, and conditions for future crises are created; veer too far toward safety, and booms are prevented from ever starting. Balancing these critical impulses requires constant re-examination and vigilance.
Evaluating the Regulatory Landscape
Now is a good time for UK financial policymakers to consider the aggregated impact of regulation across the landscape and assess any duplication and unintended consequences in supporting the growth agenda. Several critical and related questions must be answered: Has the UK’s ‘belts and braces’ approach to capital, resolvability and ringfencing frameworks since the GFC achieved its aims? Do these frameworks need to remain in their current form, or could they be carefully updated to address unintended consequences, cost and complexity? How can the UK ensure a well-coordinated regulatory landscape with comprehensive coverage but without excesses? And is there a role for non-bank actors to support banks in sharing the cost implications of the regulations, to increase stability of the financial system and improve customer well-being?
The trade-off between growth and safety is a constant balancing act for policymakers. Lurch too far toward growth and the conditions for future crisis are created; veer too far toward safety and booms are prevented from ever starting. On a philosophical level, the very act of regulating an industry affects behaviour, as the imperative of compliance begins to overtake the quest for opportunity. Balancing these two critical and competing impulses requires constant re-examination and vigilance.
In this report, we address these questions. Our analysis has four key findings:
1. Coordination is Critical for Competitiveness
No single regulatory body is accountable for international competitiveness, and no one has oversight across all regulators to ensure the total impact of regulation remains proportionate in a dynamic macroeconomic environment.
2. Strengthening Bank Resilience
Banks are less likely to fail, with stringent mechanisms to limit contagion. On ringfencing and proprietary trading, we echo the recommendations of the 2022 Skeoch review, and agree that now is the right time to align ringfencing and the resolution regime. On regulatory capital, we welcome the Prudential Resolution Authority’s (PRA) updates to the proposed near-final rules on credit risk, including revised implementation timelines, but the upcoming Pillar 2 review is key. We note small changes to capital requirements and buffers have a big impact on lending capacity; a 50 basis-point change in common equity tier 1 (CET1) capital requirements, for example, equates to approximately £60 billion of lending capacity.
3. The High Cost of Compliance
UK ringfenced banks on average devote 10 to 15 per cent of their total costs and 15 to 20 per cent of their investment budgets to regulation, primarily in the areas of economic crime, conduct, prudential controls and payments compliance. The UK is more stringent in several categories than other jurisdictions are — for example, Authorised Push Payments (APP) fraud reimbursement, which costs UK banks £287 million last year. These costs have only been compounded by the Consumer Duty, which, in its current form, is causing uncertainty for banks and investors.
Rationalising regulatory requirements and therefore regulatory-related expenditures by a modest 50 basis points of operating expenditures would give banks capacity to make an additional 5,000 mortgage loans or 60,000 small and medium-sized enterprise (SME) start up loans. The direct costs are only one component, additional conservatism in new products and mindshare of executives further constrain growth.
4. Underperformance Compared to Peers
UK banks have made progress recently but still trail their EU and US peers in revenue growth, price/book ratio, return on equity and return on assets. Investors are discounting UK banks because of regulatory and political uncertainty and their additional regulatory costs relative to peers. These findings inform a series of recommendations we believe will usher in a new era of UK banking.
