OREANDA-NEWS. The Prudential Regulation Authority's (PRA) ring-fencing policy proposals limit, but do not prevent, ring-fenced banks (RFB) to lend to non-ring-fenced sister banks (NRFB) and impose no added restrictions on dividend payments. This will allow some fungibility of funding and capital within group companies. Standalone Viability Ratings (VR) assigned to RFBs and NRFBs will therefore remain interdependent, reducing rating gaps between them, says Fitch Ratings.

The PRA has sought to eliminate the use of intra-group concessions across the ring-fence and now expects banks to apply third-party credit discipline to such exposures. This will improve analytical transparency which we view positively.

We envisage that UK banks subject to ring-fencing will adopt one of two models depending on the relative size of their non-ring-fenced activities, prior to the January 2019 deadline. Banks have to submit their plans by January 2016, according to the PRA's consultation paper published on 15 October.

VRs assigned to RFBs are likely to be constrained by limited geographical and product diversification and, provided these remain largely focused on UK retail and SME lending, we do not expect to see much ratings differentiation between them. We already indicated in our September 2014 comment, accessed by clicking on the link below, that VRs for RFBs narrowly focused on domestic retail and SME business are likely to be capped in the 'a' range.

The UK ring-fencing rules apply to banks with more than GBP25bn of core deposits from SMEs and individuals. Most banks affected by ring-fencing have very limited (if any) wholesale and investment banking activities and therefore these groups will adopt models dominated by RFBs. This will be the case for Lloyds and RBS.

In these instances, the ability of the larger RFB to lend up to 25% of its regulatory capital to the smaller NRFB should be a significant positive ratings factor for the NRFB's VR. This is because the NRFB will be able to benefit from ordinary support flowing from the larger RFB.

For groups whose non-retail, corporate and investment banking business is significant, as is the case for Barclays and HSBC, the importance of the NRFB within the restructured group is likely to be significant, or even dominant. The RFB's ability to fund its NRFB sister will likely be less material simply because of the banks' relative sizes. Under this model, we believe that management will seek to structure RFB and NRFB subsidiaries to ensure these remain robust on a standalone basis, maintaining strong and balanced funding and liquidity and meeting adequate capitalisation levels.

A clearer picture about the likely ratings outcome for RFBs and NRFBs will emerge once further details of group restructuring are available. Much will depend on exactly what activities are kept in or out of the fence. Resolution strategies ('single point of entry' or 'multiple point of entry'), depending in particular on the volumes, form and source of 'loss absorbing' debt, will also be relevant for ratings and will add a separate layer of uncertainty to ratings within a UK banking group until more clarity emerges.

But, as far as regulations are concerned, our opinion is that the PRA proposals will not create a particularly 'high' fence, reducing intra-group rating differentials. By preserving the ability to share capital and funding across RFBs and NRFBs, the PRA is demonstrating that it is keen for RFBs to continue to enjoy the benefits of remaining part of broader banking groups.