UK proposal to split retail, investment banking

ROBERT BARR - Associated Press
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With St Paul's Cathedral in the background, a sign of Lloyds TSB bank is displayed at a branch in the City of London, Monday, Sept. 12, 2011. A commission appointed by the British government says banks should isolate their investment operations from ordinary banking by 2019 to prevent taxpayers from future massive bailouts. The report released Monday also endorsed the sale of 632 branches by Lloyds Banking Group. (AP Photo/Sang Tan)

LONDON (AP) — Major British banks should separate investment banking operations from retail activities by 2019 to reduce the risks of taxpayers having to bear the cost of any future bailouts, a government-appointed commission recommended on Monday.

Treasury chief George Osborne told parliament that he accepted the recommendations in principle, and promised to report by the end of the year on the government's plans to implement them.

"The detailed work will start immediately," Osborne said.

The long-awaited report from the Independent Commission on Banking estimated its proposals would cost the banks up to 7 billion pounds ($11 billion) a year.

Shares in the major banks opened lower, with Barclays down 4.3 percent, Royal Bank of Scotland down 3.8 percent, Lloyds Banking Group 3.3 percent and HSBC 0.8 percent.

The report, which broadly echoed the proposals in an interim assessment in April, also endorsed the sale of 632 branches by Lloyds Banking Group, but did not, as some expected, call for the divestiture of even more branches.

"With the exception of Standard Chartered, the implications of the ICB report are negative to long-term return on equity prospects for all of the U.K. banks," with Barclays and RBS to be most affected, said Gary Greenwood, analyst at Shore Capital.

The recommendations are intended to avoid a repetition of the credit crisis in 2008 when the British government bought up large chunks of the country's banking system after it ran into major financial difficulties. The British taxpayer now owns mortgage lenders Northern Rock and Bradford & Bingley, 83 percent of Royal Bank of Scotland and 41 percent of Lloyd's Banking Group.

"The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers," said the commission, chaired by Sir John Vickers, a former chief economist of the Bank of England.

Vickers added that in future, banks need much more equity capital, and that their debt "must be capable of absorbing losses on failure, while ordinary depositors are protected."

The commission said retail banks should be "legally, economically and operationally separate" from the parent companies, and should have "distinct governance arrangements, and should have different cultures."

The British Bankers' Association, the industry's main lobby group, said the planned reforms "need to be carefully analyzed and compared with those agreed internationally."

In particular, it said an assessment of the reforms on the economy, the recovery and banks' ability to support their customers needs to be made.

The report recommended that the retail side of U.K.-based "systemically important banks" should be required to hold equity capital of at least 10 percent of risk-weighted assets in their retail operations — the ordinary banking functions of current accounts and lending — and additional loss-absorbing capacity of another 7 to 10 percent.

The Basel III agreement calls for banks to hold equity capital equal to at least 7 percent of risk-weighted assets.

Osborne said Britain has an especially large banking sector which requires a particular response.

"The balance sheet of our banking system is close to 500 percent of our GDP, compared to just over 100 percent in the U.S., and around 300 percent in Germany and France," Osborne said.

Ian Gordon, analyst at Evolution Securities, called the commission's recommendations "unwelcome and unhelpful, but it could easily have been a whole lot worse."

Gordon noted that the commission would give banks flexibility in deciding whether corporate banking services should be inside or outside the ring fence. The 2019 implementation date, he added, "allows banks some planning time to mitigate the likely adverse impact."

The commission ruled out a total separation of retail banking from wholesale and investment banking, in part because of the greater expense, and the potential difficulties of enforcing the changes under European law.

Though the report conceded that the complete separation "would remove a channel of contagion risk from investment banking to retail banking (and vice versa)," it said it "would preclude support for troubled retail banks from elsewhere in banking groups."

David Fleming, national officer for the Unite union, said the 2019 target date will "bring immediate uncertainty to workers across the sector, while the greedy bankers find ways to maneuver around, and lobby against, these reforms."