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Chancellor George Osborne has committed to enforce the separation of banks’ risky investment activities from more traditional personal and business lending in a bid to prevent a repeat of ‘the worst crisis in a generation’.
In a white paper today the government explained that ring-fenced banks will be prohibited from conducting the vast majority of international wholesale and investment banking. This will not stop a bank from failing, but will ensure the essential parts of the banking system – deposits and overdrafts – can continue without the need for a taxpayer-funded bailout.
Osborne has, however, agreed to widen the range of activities allowed within the ring-fenced operations to include ‘simple hedging products’ – such as protection against interest rate and currency fluctuations – to ensure small businesses have access to essential banking services. However these products must be provided in a way that does not expose the bank to increased market risk.
This is a significant concession to the banking lobby, which has fought hard to dilute the ring fencing proposals made by the Independent Commission on Banking (ICB) in its final report last September.
Mark Hoban, financial secretary to the Treasury, meanwhile, added that smaller banks, with under £25 billion worth of deposits, will be exempt from the ring fence requirements.
'Large, systemically important banks have a competitive advantage from the perceived implicit guarantee. Our targeted reforms remove that advantage, helping smaller banks and new entrants,' he explained.
The government has, however, raised the question as to whether ring fenced banks should be allowed to offer simple retail investment products. Many of the structured investment products, which are supposed to be a simpler alternative for high street investors, currently offered by banks are complex and risky in nature, which would go against what the government is trying to achieve by splitting retail and investment banking.
In its white paper the government also confirmed that savers will be given greater protection should a bank fail. At present bondholders are first in line for compensation, but the ICB’s proposals will see individual deposit holders ranked above bondholders in the event of a collapse.
The banking industry argues the move will lead bondholders to demand higher interest rates and result in increased borrowing costs for both individuals and businesses.
Richard Lloyd, executive director of Which?, however, said: 'Never again should consumers have to foot the bill for a banking bailout that last time cost every man, woman and child £2,000'.
The government also confirmed its support for:
New liquidity rules will require large banks to have at least 10% equity capital – some 3% more than the new international 7% minimum – as a safety net for future crises.
Critics, however, still claim the new liquidity regulations will hamper banks’ incentives to lend.
Matthew Fell, of employers' organisation the CBI, said: 'The proposals for additional capital requirements are above and beyond those already agreed internationally, which will make it harder for banks to lend to businesses'.
Andrew Tyrie, chairman of the Treasury Select Committee, meanwhile, added that while it is right to require that banks hold more capital and liquidity, the UK now has the eurozone crisis to contend with, further hampering economic recovery.
'The eurozone crisis requires us to take stock of the speed at which we continue to demand that banks hold extra liquidity,' he said.
The government has, however, watered down the amount of capital Vickers recommended banks should have as a backstop that is independent of risk– known as the leverage ratio – insisting it can't be inconsistent with the international standard of 3%.
Speaking on competition, Sarah Brooks of Consumer Focus – which broadly welcomed today's measures – said: 'It is essential that real competition in retail banking is increased – this means encouraging diverse providers to enter the market – banks, mutual and credit unions rather than just more of the same'.
'There is always a risk of banks becoming complacent if they don’t need to fight for a customer’s loyalty,' she added.
The white paper confirmed the government will pass all legislation by 2015, but reforms will not be implemented by the banks fully until 2019.
The news comes as Osborne prepares to give his annual Mansion House speech on the future of British banking in the City this evening.