Reforms could cost banks £7bn per year

Banks will have to ring-fence their retail lending businesses, protecting them from riskier activities such as investment banking.

They will also have to keep billions of pounds in extra capital in a bid to avoid a repeat of the financial crisis, when massive injections of Government cash were required to bail out Lloyds and Royal Bank of Scotland.

Chancellor George Osborne said he would fast-track legislation based on the proposals from the Independent Commission on Banking (ICB).

In its report, the ICB said banks must hold core capital of at least 10 per cent of risk-weighted assets in their domestic retail operations. They will have to hold a further seven to 10 per cent of capital, which can be used to recapitalise a bank if it runs into trouble.

This means banks will have to hold loss-absorbing capital of between 17 and 20 per cent, a level that only the Swiss plan to introduce.

Jane Coffey, a fund manager at Royal London Asset Management, said: “We’re getting right up there with the Swiss in terms of having the most onerous capital regime.”

But other commentators welcomed the stringent new rules.

In a statement Yorkshire Building Society said: “Yorkshire Building Society supports much of the ICB’s market analysis of the shape and structure of the UK banking sector. Although the sector is already a lot safer than it was in 2007 when the financial crisis began, we agree with the ICB that a fundamental overhaul of the system is needed.

“It is crucial that going forward, retail deposits should not be used to cross-subsidise a wholesale business in a way that exposes the retail entity to failure should the wholesale business collapse.”

The ICB, led by Sir John Vickers, estimated its proposals will cost UK banks between £4bn and £7bn a year. It recommended the reforms be completed by 2019.

The Government backed the report, saying it would help boost the economy and protect taxpayers.

“John Vickers himself sets out a timetable and I intend to stick to his timetable. So he says let’s have all the changes in place by the end of this decade,” said Mr Osborne.

Business minister Vince Cable also backed the report, reducing fears that disagreement among the coalition partners could hold up legislation.

The UK’s ‘Big Four’ banks – Barclays, HSBC, Lloyds and RBS – have fought against tough new regulation on top of EU and global reforms.

Barclays and RBS are expected to be hardest hit by the reforms because they have the biggest investment banking units.

The report was better news for Lloyds as the ICB backed down from an earlier recommendation that it should sell more branches than the 632 regulators have told it to offload following its absorption of Halifax parent HBOS during the crisis.

The proposals will impose a ring-fence, limiting how much money banks can take from their retail banking divisions to fund investment banking activities.

This will increase funding costs, which critics said will hit profits and make it harder to lend to businesses.

HSBC, Barclays and Standard Chartered have all warned they could leave Britain if regulations become far more onerous than elsewhere.

Sir John downplayed the threat, saying Government guarantees to keep banks afloat have to be removed.

“If a bank effectively says I’m here because I get a UK taxpayer subsidy and without that I don’t want to be here, then it’s not a good idea for the UK to say please stay, we’re quite happy to subsidise you,” said Sir John.

John Longworth, director general of the British Chambers of Commerce said: “There are real concerns that ring-fencing may limit banks’ ability to lend to small businesses.”

Between one trillion and two trillion pounds’ worth of assets is likely to be held inside the ring-fence. UK banks have total assets of six trillion pounds, four times the size of the UK’s GDP.

The ICB’s recommendations

The ICB has made recommendations in three key areas: the retail ring-fence, loss-absorbency and competition.

The ring-fence will protect everyday high street banking services, such as current account deposits, from riskier investment divisions.

Ring-fenced banks should be separate legal entities and have an independent board. The commission wants banks to hold at least 10 per cent of equity capital to act as a buffer against potential losses or financial crises – this exceeds the seven per cent laid out in the Basel III standards. Banks should also have a so-called loss-absorbing capacity of 17 to 20 per cent of total assets.