Ring-fencing in financial networks

Marco Bardoscia () and Raymond Ka-Kay Pang
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Marco Bardoscia: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Raymond Ka-Kay Pang: London School of Economics and Political Sciences

No 1046, Bank of England working papers from Bank of England

Abstract: Ring-fencing is a reform of the UK banking system that requires large banks to separate their retail services from other activities of the group, such as investment banking. We consider a network of bilateral exposures between banks in which financial contagion can spread because banks incorporate the creditworthiness of their counterparties into the valuation of their assets. Ring-fencing acts as an exogenous shock that impacts the creditworthiness of banks through leverage, depending on how assets are allocated between ring-fenced and non-ring-fenced entities. We find conditions on this allocation that leads to safer ring-fenced entities and less safe non-ring-fenced entities when compared with their groups prior to the implementation of ring-fencing. We also show that ring-fencing can make both the equity of individual banking groups and the aggregate equity of the banking system decrease. When this happens, ring-fenced entities are safer than their groups prior to ring-fencing.

Keywords: Ring-fencing; financial networks; systemic risk (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2023-10-19
New Economics Papers: this item is included in nep-ban, nep-cba and nep-net
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:1046

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