Banking Law

Private Transactions and Regulatory Frameworks

Andreas Kokkinis, Andrea Miglionico

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000335552
• Edition: 1
• Topic: Économie
• Subtopic: Banques et services bancaires

Banking regulation and the private law governing the bank-customer relationship came under the spotlight as a result of the global financial crisis of 2007–2009. More than a decade later UK, EU and international regulatory initiatives have transformed the structure, business practices, financing models and governance of the banking sector. This authoritative text offers an in-depth analysis of modern banking law and regulation, while providing an assessment of its effectiveness and normative underpinnings. Its main focus is on UK law and practice, but where necessary it delves into EU law and institutions, such as the European Banking Union and supervisory role of the European Central Bank. The book also covers the regulation of bank corporate governance and executive remuneration, the promises and perils of FinTech and RegTech, and the impact of Brexit on UK financial services.

Although detailed, the text remains easy to read and reasonably short; pedagogic features such as a glossary of terms and practice questions for each chapter are intended to facilitate learning. It is a useful resource for students and scholars of banking law and regulation, as well as for regulators and other professionals who are interested in reading a precise and evaluative account of this evolving area of law.

Part I
Banks and their regulators

This part introduces the reader to the notion of a bank and the different types of credit institutions before examining the UK and the EU regulatory framework within which banks operate.

1 The banking system

1.1 Introduction

This chapter serves as an introduction to the book and intends to familiarise the reader with the nature and specificities of banks’ business, and the rationales for and types of regulation that banks are subjected to. The discussion starts with a brief account of the historical development of the banking sector in the UK including the development of the legal forms used by banking firms. It then examines the legal definition of credit institutions in EU law; the main types of banks, including virtual banks; and the economic functions and special characteristics of banks. Furthermore, the chapter explains why banking regulation is necessary, and it distinguishes between conduct of business regulation and prudential regulation, further elaborating on the distinction between macro-and micro-prudential regulations. The chapter concludes with a broad assessment of recent and current regulatory trends in the financial markets which canvasses the key challenges facing banking regulators and supervisors in the UK and the EU.

1.2 The historical development of banks and the global financial crisis

Banks and other financial institutions have played a major role for a long time in the economy of the UK. After the establishment of the Bank of England in 1694 and the Bank of Scotland in 1695, banking grew steadily in tandem with industrial capitalism. Originally, all private sector banks operated as partnerships without separate legal personality and limited liability. The history of the introduction of limited liability in the UK is interesting in its own right,¹ but here we will focus on the adoption of limited liability by banking firms, which followed a slightly different path from other companies. This largely reflects the early recognition of the special features of the banking sector that make limited liability a potential threat to the public interest. Indeed, limited liability became available for companies in general by virtue of the Limited Liability Act 1855, while the possibility to incorporate and acquire separate legal personality by registration was introduced by the Joint Stock Companies Act 1844. Both Acts excluded banks from their scope, as did the Joint Stock Companies Act 1856 which codified and expanded company legislation.²

1 See e.g. Robert A. Bryer, ‘The Mercantile Laws Commission of 1854 and the Political Economy of Limited Liability’ (1997) 50 Economic History Review 37. From the perspective of banks, see e.g. Lucy A. Newton, ‘The Birth of Joint-Stock Banking: England and New England Compared’ (2010) 84 Business History Review 27. From a US perspective, see Stephen M. Bainbridge and M. Todd Henderson, Limited Liability: A Legal and Economic Analysis (Edward Elgar Publishing 2016) 21–43.

2 John D. Turner, Banking in Crisis: The Rise and Fall of British Banking Stability, 1800 to the Present (CUP 2014) 39–41.

In England until 1826, banks could only operate as common law partnerships with an upper limit of six partners that had been introduced in the early 18th century.³ The Banking Copartnerships Act 1826 allowed banks to become joint stock companies for the first time which had been common practice in other sectors for years.⁴ Joint stock companies had no separate legal personality, and their shares were only a share of the joint stock assets and were not transferable without the approval of the directors. The Joint Stock Banks Act 1844 clarified that the Joint Stock Companies Act did not apply to banks which could only obtain legal personality via a royal charter for a maximum duration of 20 years.⁵ It was only when the Joint Stock Banking Companies Act 1857 was enacted that banks were allowed to incorporate as companies with legal personality without a Charter and still with unlimited liability and a requirement of a minimum denomination of shares at £100, a significant amount at the time, thus rendering banks’ shares illiquid. Limited liability first became available to banking companies in 1858 by virtue of the Joint Stock Banks Act 1858. The minimum share denomination requirement was abolished by the Companies Act 1862, thus integrating the company law framework for banks within the general company law framework, albeit with some special provisions.⁶

Nevertheless, banks were initially reluctant to adopt the legal form of a limited liability company, as depositors continued to rely heavily on bank shareholders’ personal wealth as a reassurance that their deposits were safe. Indeed, by the mid-1870s only seven English banks (out of a large number of banks in existence) had incorporated as limited liability companies, although the Act was being adopted by the most newly established banks.⁷ This trend changed only after the infamous collapse of the City of Glasgow Bank in 1878, which led to catastrophic financial losses for its shareholders, many of whom were middle-class individuals.⁸ By 1884 nearly all UK banks had adopted limited liability. Still, most of them issued high amounts of uncalled share capital, thus maintaining the liability of certain shareholders to contribute up to that amount in case of insolvency and made use of the possibility introduced by the Companies Act 1879 to issue reserve share capital,⁹ which was similar to uncalled capital but could only be called by the company in case of insolvency. Thus, in late 19th-century Britain, a large portion of the total value of deposits were covered by banks’ called-up share capital, uncalled capital and reserve capital.¹⁰ This practice faded gradually until the 1950s when the level of coverage of deposits by capital reached the very low level of around 5% at which it has more or less remained.¹¹ It was only during the 1980s that the majority of investment banks, originally operating as partnerships, completed the same process of adopting the corporate form, or were acquired by retail banks.

3 Ibid., 36.

4 Ibid., 38.

5 See Bishop C. Hunt, The Development of the Business Corporation in England, 1800–1867 (Harvard University Press 1936) 96.

6 On the application of the Act on insurance companies and companies formed ‘for the purpose of carrying on the business of banking’, see Companies Act 1862, ss 3–4. The full text of the Act can be found online at <http://www.irishstatutebook.ie/eli/1862/act/89/enacted/en/print.html?printonload=true> (accessed 1 August 2020).

7 Turner (above n 2) 41 and 124.

8 An account of the events surrounding the bank’s failure can be found in Leo Rosenblum, ‘The Failure of the City of Glasgow Bank’ (1933) 8 The Accounting Review 285, esp. 289–291. See also Turner (above n 2) 120–123.

9 The difference between uncalled share capital and reserve share capital was that reserve capital was not callable at the directors’ discretion but, rather, only if the bank went insolvent and had inadequate funds to repay depositors. On this generally, see Lewis T. Evans and Neil C. Quigley, ‘Shareholder Liability Regimes, Principal-agent Relationships, and Banking Industry Performance’ (1995) 38 Journal of Law and Economics 497.

10 Indeed, shareholder capital in a broad sense covered 70% of deposits in 1885, but only 40% in 1900. See Turner (above n 2) 128–129.

11 Ibid., 129–131.

Furthermore, during the 1980s and 1990s, most of the UK’s building societies, which are co-operative banks functioning as mutual institutions, transformed into public companies or merged with banking corporations. Thus, since the 1990s the greatest part of retail and investment banking activity is being carried out by financial conglomerates, which are structured as groups of companies ultimately owned by a parent public company which has its shares listed on the London Stock Exchange. The abolition of foreign exchange controls in 1979 and deregulation of the 1980s, culminating in the so-called ‘Big Bang’ of 1986, allowed banks to engage in securities trading, and generally to adopt risky business strategies of their own choice under the generally liberal supervision of the relevant authorities: the Bank of England until 1998, the Financial Services Authority from 1998 to 2013, and currently the Prudential Regulation Authority and Financial Conduct Authority.¹² The late 1990s and early 2000s witnessed a steep increase in financial sector activities, which up until the 2008–2009 financial crisis grew at a significantly faster pace than the rest of the economy. Indeed, financial intermediation contributed 9% of the UK’s GDP in 2008,¹³ and the assets of the banking sector amounted to more than 500% of GDP in 2006.¹⁴

This period of rapid development came to an end with the first run on a UK bank after more than a century, namely the run of depositors on Northern Rock in September 2007. The cataclysmic events that followed, including the partial nationalisation of the Royal Bank of Scotland (RBS) and Lloyds Banking Group in 2009,¹⁵ have left a lingering legacy of public distrust in the UK financial system.¹⁶ Lloyds has now returned to 100% private sector ownership, while the government still owns a controlling stake in RBS, which made its first profit since 2007 only in 2017.¹⁷ Considering the prominence of the banking sector, it was unsurprising that the UK felt the consequences of the global financial crisis more severely than most continental European countries, and that its economy entered a deep recession. The UK government’s support to the banking sector peaked at £1,162 billion in 2009, while the direct cost of bank rescues to the Treasury stood at £51 billion at the end of March 2013.¹⁸ The final direct cost to the Exchequer will depend on the price at which the remaining government shares in RBS are eventually sold.

12 For a discussion of the evolution of financial regulation architecture in the UK, see Chapter 3.

13 See Stephen Burgess, ‘Measuring Financial Sector Output...