Banks urged to protect retail arms

The Commission is also calling for Lloyds Banking Group to sell more of its branches to improve competition in the sector, although it has stopped short of recommending a reversal of the HBOS rescue takeover.

Today’s interim report - which will be followed by final recommendations in September - suggests measures designed to reform the industry following the financial crisis and protect taxpayers against future bailouts.

The head of the review, Sir John Vickers, said there was an “arguable case” for splitting retail banks from investment banks.

But he told the BBC Radio 4 Today programme: “We believe that you can get adequate protection of the retail side with lower cost to the system as a whole with the retail ringfence idea.”

Sir John said the proposals were a “moderate combination of the strategies rather than maxing out on total structural separation or indeed maxing out on super-high capital requirements”.

Sir John also said the decision to allow Lloyds to merge with HBOS had been a mistake.

“This was certainly not good for competition and it turned out to be bad for financial stability as well,” he added.

He said he supported making the new Lloyds group shed more branches than the 600 ordered by European authorities, insisting: “While that would do something for competition, it’s possible to do a great deal more.”

The ICB said ring-fencing banking operations would have “several advantages”, by shielding savings deposits and addressing the “too big to fail” issue in the event of a future crisis.

This could be combined with tougher requirements for banks to hold more capital aside as a cushion to limit taxpayer exposure.

The watchdog believes that current international capital ratio rules do not go far enough and should be increased from 7% to at least 10%.

However, it has held off from the more radical options of restructuring the industry, saying a full-blown separation would be costly and could “lose some of the benefits of universal banking”.

Instead the sector is facing a call to set up so-called internal firewalls to draw a line between the two.

Lloyds appears to have avoided its worst-case scenario to undo the HBOS takeover, despite now having a uniquely powerful position in the sector - accounting for around 30% of all current accounts in the UK.

However, the ICB made clear it believes Lloyds should offload more than the 600 branches and parts of its mortgage business being divested under current European measures to address competition concerns.

Switching between banks should also be made easier and quicker to allow new entrants to crack the market and help improve competition, added the ICB.