Insight & Analysis

UK bank ring-fencing a fraudster’s charter

Published: Sep 2017

Corporates face a heightened risk of fraud as banks in the UK work to comply with ring-fencing rules.

The UK’s ring-fencing rules intended to make finance safer could trigger a surge in fraud, claims Stuart Gulliver, CEO at HSBC. With over one million account holders, both individual and corporate, currently being contacted about changes to their bank accounts details, Gulliver’s concern is well founded.

“Treasurers clearly need to be vigilant when receiving information supposedly from their UK banks at the moment,” comments Marcus Hughes, Director of Business Development at Bottomline Technologies. “Fraudsters know that all the changes currently happening are creating a window of opportunity for them to pretend to be the bank and persuade somebody to reveal their credentials, or worse still, fool them into making a payment to a fraudulent bank account.”

Walls of safety

The ring-fencing projects being undertaken by the UK’s largest banks have come about following the Vickers Report into the UK banking sector, prepared in the wake of the global financial crisis. The report recommended that banks operating in the UK must ‘ring-fence’ their high street banking activity from a range of more-risky investment banking and global banking activities.

Applying to banks in the UK that have over £25bn worth of retail deposits, the rules aim to safeguard retail customer deposits by ensuring the banks can continue to operate in the event of a failure of the investment banking arm. The rules will also enable the Bank of England to let investment banking operations collapse, but keep the retail bank running in the event of a bail-out.

For treasurers dealing with many different parts of the affected banks, this could add complexity to the relationship. This is especially true considering that core treasury services, such as lending and trade finance, can sit on either side of the ring-fence. Corporates are likely going to have to deal with both the ring-fenced and non-ring-fenced bank after the 2019 deadline.

Major upheaval

The size of the task facing the UK’s banks should not be underplayed. In purely financial terms, ring-fencing will cost billions. HSBC estimates that it will cost just under £2.5bn. Meanwhile, Barclays says it will cost around £1bn.

The cost comes from the sheer complexity that restructuring a major banking institution poses. “Ring-fencing is forcing UK banks to significantly restructure their operations,” says Hughes. “There is a lot for them to consider, spanning legal, operational, governance, technological and management issues.”

This is especially true for those universal banks that typically do everything within the same legal entity. “In the case of these banks, such as HSBC, they have had to set up an entirely new legal entity (HSBC UK). They are now in the process of shifting assets and separating the systems out,” adds Hughes. “The new legal entity may also need to establish direct membership with CHAPS and establish separate Nostro accounts with correspondent banks. No matter which way you look at it, it is a big task.”

The work required to separate tightly-integrated systems (and the risk this poses) is almost overwhelming. Even seemingly more simple tasks, such as staffing the new banks, is proving to be an issue, especially where a change of location is required.

Each bank is not facing the same challenge, however. Lloyds, for example, is less impacted. This is due to its existing legal structure and scope of operations, which means that 97% of its activity can sit within the ring-fence.

Banking blackouts

The process of ring-fencing is creating risks, as is to be expected with any major banking upheaval. We have already mentioned that the risk of fraud is likely to increase as banks contact customers with a flurry of information about changes in sort codes and other bank account details.

“Corporate should be aware of this risk and be especially vigilant over the next 18 months,” says Hughes. “I would advise that treasury teams work to get clear visibility over their cash balances and the transactions into and out of their accounts. They should also consider using tools that monitor what is happening across their bank accounts and alert them to any strange or anomalous activity. In many cases, this is standard best practice, but right now the risks are even higher than normal.”

Corporates may also face operational risks from the banks’ ring-fencing projects. The Bank of England has recently warned UK bank customers of some disruption. Barclays, has also announced that there will be service blackouts on their online and telephone banking services for one weekend every month until 2018.

Hughes notes that whilst banks are doing their utmost to avoid any severe service disruptions for corporate customers, that does not mean there will not be any though. “Anytime there is a big infrastructure project within a bank there is always the potential for significant failures or for mistakes to be made,” says Hughes. “We haven’t seen this yet, and hopefully we won’t, but treasurers need to be alert to the possibility.”

Next actions

With banks needing to have completed their ring-fencing projects by January 2019, many are well under way with their work. Hughes advises corporates to ask their banks questions about their ring-fencing approach and seek clarification of activities that will sit inside and outside the ring-fence.

“When having these conversations, treasurers will need to ascertain how ring-fencing will impact their accounts, the relationship managers that they work with and how the bank can service them once the ring-fencing project is completed.”

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