June 15, 2011 / 9:15 AM / 7 years ago

UK set to shelter retail from casino banking

LONDON (Reuters) - Britain’s top banks will have to protect their retail business from investment banking activities after the government backed a plan to overhaul the industry and shield taxpayers from future losses.

Chancellor George Osborne will on Wednesday throw his weight behind the ring-fencing proposal, Treasury sources said, in a move aimed at showing the public the coalition government is fulfilling its promise to be tough on the banks.

“This is a regressive and costly outcome for UK banks, although perhaps a more palatable option than full break-up,” said Mike Trippitt, analyst at Oriel Securities.

The reforms go further than measures being proposed by other countries, although the capital requirements are not likely to be as harsh as in Switzerland.

But full details of the plan, which aims to shield retail depositors and ensure taxpayers are not required to bail-out the industry in any future crisis by creating much larger capital cushions, have not yet been finalised.

It is likely to see domestic banking become a low-risk utility service, while riskier investment banking -- dubbed “casino banking” -- will face higher funding costs, potentially forcing some firms to shrink or reshape.

While a blow to the banks, some had expected the proposals to be more severe. As now proposed they are unlikely to prompt banks to follow through on threats to leave Britain in favour of lighter touch regulatory regimes, industry analysts said.

Shares in HSBC (HSBA.L), Barclays (BARC.L) and Royal Bank of Scotland (RBS.L), those most affected, all fell by more than 1 percent after the news that Osborne would use the annual Mansion House speech in the City of London to endorse the plan.

“It’s yet more regulation that they’re going to have to deal with which will impact their profitability,” said Ion-Marc Valahu, fund manager at Geneva-based ClairInvest, which owns bonds in Barclays.

Osborne is backing the central plank of proposals put forward by Britain’s Independent Commission on Banking ICB.L to ring-fence UK retail banking operations.

He will not provide details of what assets should be ring-fenced nor capital levels, but will make clear the separation should allow retail to keep functioning if investment banking operations were wound down, a Treasury source said.

Banking sources said they were surprised Osborne was endorsing the ICB’s proposals three months before the full report is released and there is more clarity.

Full details of the plan will not be released by the ICB until September 12, and banks and analysts said more details are needed to assess the impact and cost.

The ICB, which has stopped short of recommending a full break-up, expects the ring-fence to be introduced alongside other reforms, such as detailed plans to allow an orderly wind-down of a lender when it hits trouble.

Banks should hold a minimum core Tier 1 capital ratio of 10 percent for the UK retail operations, which may be near to overseas rivals as big global banks face a top-up requirement over the current 7 percent global minimum standard.

    Critics say the proposals wouldn’t have stopped the collapse of UK mortgage lenders Northern Rock or Bradford & Bingley.

    The plan represents a compromise, allowing the Conservative-Liberal Democrat coalition to appease public anger against the banks by showing taxpayers that the banks are being reformed, while not harming Britain’s competitive position.

    The ICB said the costs of the process “may be material” but would fall far short of one estimate of 12 billion pounds.

    The top banks are split over how ring-fencing would work. HSBC and Lloyds favour a broad ring-fence including far more assets than a set-up supported by Barclays and RBS.

    HSBC last week told lawmakers that all banking book assets should go behind the ring-fence, which would include mortgages, corporate loans and all long-term assets it holds being protected by a government guarantee.

    It fears a narrow UK retail ring-fence would have far more deposits than loans, leaving its investment banking business needing to raise more costly funds in wholesale markets.

    But RBS CEO Stephen Hester warned that creating too big “a protected beast” raised the moral hazard, as banks could make riskier loans knowing they were covered by a state guarantee.

    If the new rules allow for the investment banking arms of Barclays, RBS and HSBC to fail in the event of a crisis, as appears likely, investors may demand a higher cost to provide them with capital or more discipline on pay, analysts said.

    Banks shares trimmed early losses and by 1107 GMT Barclays and HSBC were down just over 1 percent, RBS was down 0.8 percent and Lloyds was near flat.

    Additional reporting by Christina Fincher; Editing by Hans Peters and Alexander Smith

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