This is portion of Out-Law’s series of news and insights from Pinsent Masons experts on the impact of the UK’s EU referendum. Watch our video on the issues facing businesses and sign up to receive our ‘What next?’ checklist.

In a letter to Treasury Select Committee chairman Andrew Tyrie (9-leaf / 5.90MB PDF), the chief executives of the businesses said reducing regulatory burdens, particularly in revere of the amount of capital small banks desire to clutch in reserve to underwrite credit risks, would aid improve competition in the UK banking market.

The letter was signed by Phillip Monks of Aldermore Bank, Ian Lonergan of Charter Savings Bank, Graeme Hartop of Hampden and Co, Craig Donaldson of Metro Bank, Andy Golding of OneSavings Bank, Paul Lynam of Secure Trust Bank, and Steve Pateman of Shawbrook Bank.

“The EU referendum result, once implemented, means HM Government and the Bank of England will own the discretion to determine which aspects of legislation derived from the EU they wish to be maintained in the UK and which they wish to reform,” the CEOs said in the letter.

“We hope that will result in a more proportionate approach to the regulation of smaller banks, particularly in revere of capital. This will aid smaller banks and building societies compete more effectively and provide more credit to the economy which will be useful especially should the dominant incumbents reduce their lending appetite in a post Brexit environment,” they said.

The chief executives said existing capital rules place them at a competitive disadvantage compared to the biggest banks in the market. They said that while the UK government’s commitment to the creation of recent banks is “laudable”, it said it was a “flawed strategy” to subject recent banks to “exactly the same funding, capital, taxation and regulatory burden disadvantages”.

“For taking exactly the same credit risk the smaller lenders own to set aside ten times more capital than the six biggest firms that control 80% of the mortgage market,” the CEOs said in their letter.

“Without a far reaching holistic approach smaller banks will remain restricted to a narrow portion of the market which is underserved by the larger banks. In consequence the small banks will generally own riskier lending portfolios than average (because they cannot economically record lower risk lending due to funding and capital disadvantages). Inevitably if the pool of opportunity available to the smaller banks becomes too crowded the challengers will become the challenged. Ultimately too numerous fish in too small a pool leads to asphyxiation. The Too huge to Fail banks (few in number but absolutely huge) will persevere to dominate the huge majority of the market,” they said.

Post-Brexit, the UK could reduce the capital burdens on small banks by adopting the “US approach” to existing Basel international standards on the minimum amount of capital banks must clutch relative to their credit risk exposure. In the US “Basel is only imposed in full on the systemic banks and a more proportionate approach is adopted for every other banks”, the letter said.

“In the wake of the ‘goaway’ vote, we believe there is potential for the BoE / PRA to consider whether to adopt the US approach once the UK is outside of the direct remit of the EBA,” the CEOs said. “This could for example create an option of allowing the established smaller banks to risk weight their lending assets at the average of the ten biggest firms using the IRB approach. Those larger firms with a lower risk profile than average would persevere to own a capital advantage which would arguably be justified by their profile. Overall the huge differential that exists would be considerably narrowed without imposing punitive costs on the smaller firms.”

The CEOs said, though, that they did not contemplate the option is “favoured” by the Prudential Regulation Authority. They therefore suggested an alternative solution may be to compel the ‘huge six’ UK banks to “share anonymised lending data” with smaller banks to permit those challengers to “transport onto an internal modelling approach to risk weights”.

“Smaller firms would be capable to operate the anonymised data, using every of the characteristics therein, to build internal models, enhancing their own (limited) data and thus providing assurance to the regulator regarding the robustness of their assumptions,” the CEOs said.

They said having more data would also aid smaller banks with benchmarking “when validating the results of their internal models”.

Expert in financial regulation Chris Davidson of Pinsent Masons, the law firm behind Out-Law.com, said: “The challenger banks also focussed on the ability of the challenger banks to operate low risk loan assets, to access low cost funding which is then used to originate recent low cost loans. This, coupled with their capital advantages, represents a ‘virtuous circle for the huge banks’ and a ‘vicious circle for other lenders’.”

In response to the letter, Andrew Tyrie said: “Brexit poses risks; it may also create opportunities. Current EU legislation could be placing smaller banks at a disadvantage. This is because it risks imposing a ‘single size fits every’ approach to banking regulation. The Bank of England and the government both now desire to consider whether the opportunity afforded by Brexit could enable the development of a regulatory regime less prejudicial to small and challenger banks.”

Davidson also noted comments from Sam Woods priorto the Treasury Select Committee on Thursday. Woods has succeeded Andrew Bailey as deputy governor for prudential regulation and head of the PRA. Woods admitted “there is a genuine issue” in revere of bank regulation and agreed with Tyrie’s request to “hold it high on the agenda in his recent toil”.