UK to split up banks into retail, investment

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 (ICB) estimated its proposals would cost the banks up to £7 billion (US$11 billion) a year.

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 UK banks," with Barclays and Royal Bank of Scotland (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 per cent of RBS and 41 per cent 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 analysed 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 UK-based "systemically important banks" should be required to hold equity capital of at least 10 per cent of risk-weighted assets in their retail operations - the ordinary banking functions of current accounts and lending - and additional loss-absorbing capacity of another 7-10 per cent.

The Basel III agreement calls for banks to hold equity capital equal to at least 7.0 per cent 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 per cent of our GDP, compared to just over 100 per cent in the US, and around 300 per cent in Germany and France," Osborne said.

The commission has 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."