Banks must ring-fence retail operations, Osborne to say
Chancellor George Osborne is backing proposals to force banks to ring-fence retail from investment banking.
In a speech on Wednesday he will say banks must be set up so that their High Street branches and savings and loans would not be damaged if their trading arms ran into trouble.
The legal separation of the functions of big banks was recommended by the Independent Commission on Banking.
He will also announce the privatisation of Northern Rock.
The former mutual was nationalised in February 2008, in the early stages of the financial crisis.
The BBC's business editor, Robert Peston, said the changes would represent "the most significant reform to our banking system since Big Bang in 1986 made it much easier for our giant banks to buy stock brokers and become huge in investment banking".
In his annual Mansion House speech, Mr Osborne will also say that banks should have to hold more capital to protect themselves against future losses than the new international minimum of 7% of their risky assets.
He will not put a figure on what minimum he will impose, but Treasury sources said that 10% would be "the right ballpark".
The 10% minimum was another recommendation of the Independent Commission on Banking (ICB) in its interim report in April.
At the time, Mr Osborne welcomed the report, but he has not previously endorsed its findings.
The shadow chancellor, Ed Balls, has also given the commission his backing.
"To protect customers and taxpayers we need tough accountability and transparency and clear, workable and robust firewalls," he said.
The commission's final report, which is expected to give details of how banks' firewalls will work, is due to be published on 12 September.
The chancellor will announce in his speech how he plans to relinquish state control of Northern Rock.
The former mutual has been split into a "good bank", containing customers' savings and about 70 branches, and a "bad bank" containing the more toxic loans.
The former is set to be sold, while the latter will continue to be owned by the Treasury.
However, Mr Balls called for Northern Rock to be mutualised rather than sold off, and accused Mr Osborne of failing to give the option serious consideration.
According to Robert Peston, the purpose of ring-fencing is to ensure that in a major crisis "a retail bank could be hived off and saved by the Bank of England at less cost to taxpayers, because the investment banking part of the same bank would be allowed to fail".
"The minutiae of how retail banking operations are to be insulated from investment banking are yet to be worked out. The practical and legal challenges are formidable."
Angela Knight of the British Bankers' Association conceded that the banks had different views on how this should be done.
"There's a lot of issues and a lot of details that needs to be thought through and discussed," she said.
Stephen Hester, chief executive of the semi-nationalised Royal Bank of Scotland, told MPs last week that putting retail banks into separate subsidiaries could increase the riskiness of the banking system and put up costs for banks and their customers.
But the boss of HSBC, Doug Flint, told the same committee hearing that ring-fencing was a good idea.
Some commentators have said the government should go further, and completely separate investment banks from retail banking altogether, instead of allowing them to remain as ring-fenced businesses within the same company.
"While [ring-fencing] is intellectually a sound move, the problem is that in practice, with the pressures of the real world, the ring fence will not be completely... watertight," said Lord Lawson, who was Chancellor of the Exchequer under Margaret Thatcher.
"I'm quite sure the banks would like them to be permeable."
Speaking to BBC Radio 4's Today programme, he said there would need to be two totally different cultures - "prudence and caution" in retail banking, and a "go-go" culture in investment banking.
"If investment bankers make a mistake, they should go bust," he said, and it was "absolutely intolerable" that they could be bailed out along with the retail banks.
The reforms are not expected to make the UK banking system completely risk free, according to Alistair Milne of the Cass Business School.
"I don't think anybody on the Vickers Commission thinks [ring-fencing] is a magic solution that will make all potential banking problems go away," he told the BBC, although he said it would make High Street banking safer.
Instead, Mr Milne said it was about "removing the clear subsidy that has existed in the past" that enabled banks to "borrow cheaply on the basis of having all their retail activities, and use that for quite risky business".
However, removing this subsidy will not be cost-free for banks' customers, according to banking analyst Ralph Silva of SRN Research.
"Bottom line - the price of the products is going to go up for everyone in the UK," he told the BBC, estimating that the increase in cost for customers would be 10-15%.