(Updates with closing share prices in 14th paragraph.)
Sept. 12 (Bloomberg) -- Britain’s government will force lenders to insulate their consumer banking units by 2019 as Chancellor of the Exchequer George Osborne seeks to shield customers and taxpayers from another financial crisis.
The Independent Commission on Banking, chaired by former Bank of England Chief Economist John Vickers, recommended in a 360-page report published today that banks build fire breaks between their consumer and investment banks. The plans will cost the industry as much 7 billion pounds ($11 billion), the report said. Osborne, 40, pledged the government will legislate by the end of the current parliamentary session in 2015. British bank shares fell.
“John Vickers has set out a timetable,” Osborne told reporters today. “I intend to stick to his timetable.”
The government last year asked Vickers, 53, to chair a commission considering ways to enhance competition and reduce the risks posed by the financial industry. U.K. banks including Lloyds Banking Group Plc, Royal Bank of Scotland Group Plc and Barclays Plc lobbied the commission and the government to delay implementation if it went ahead with the fire break plan, arguing it could harm the U.K.’s faltering economic recovery.
“The proposals that we recommend pose no significant risk to the economic recovery,” Vickers said at the press conference. “Indeed the lesson from recent weakness and the strains being shown by banks show just how important it is to reform the banking system.”
Asked whether politicians might accept some of the proposals and not others, Vickers said “pick-and-mix would be a grave mistake.” The commission had designed a coherent package and weakening the fire breaks “could blow apart the whole concept,” he told journalists.
Once the recommendations are implemented, the so-called ring-fenced units will include all checking accounts, mortgages, credit cards and lending to small- and medium-sized companies, the report said. As much as a third of U.K. bank assets, or about 2.3 trillion pounds, will be included, the document said. Trading and investment banking activities will be excluded from the ring-fence.
“The commission believes that ring-fencing would achieve the principal stability benefits of full separation but at lower cost to the economy,” the commission said in the report.
Since 2007, the British state has been forced to spend, pledge and loan 850 billion pounds to rescue British banks, according to the National Audit Office.
Osborne described the report as “impressive” and “an important step towards a new banking system that supports lending to businesses and families, supports the economy and jobs, but doesn’t cost the taxpayer billions of pounds when it goes wrong,” according to an e-mailed statement today.
‘Unwelcome and Unhelpful’
The report “is unwelcome and unhelpful, but it could easily have been a whole lot worse,” according to Ian Gordon, an analyst at Evolution Securities in London said in a note to clients today. “The additional breathing space will certainly avoid any lingering fears of a requirement for fresh equity issuance, and most importantly, allows banks some planning time to mitigate the likely adverse impact of segmentation on funding costs.”
Large banks should hold between 17 percent and 20 percent of “loss absorbing capacity” the report said, including equity. The remainder could be held as bail-in bonds, it said.
“Barclays will be the bank that is hit the most by this,” followed by RBS, said Shailesh Raikundlia, a banking analyst at MF Global Ltd. in London. Both London-based Barclays and Edinburgh-based RBS operate investment banks.
RBS led British banks lower, falling by 3.4 percent to 20.77 pence at the close of London trading, while HSBC Holdings Plc lost 2.4 percent to 492.55 pence, Barclays dropped 1.6 percent to 141.65 pence and Lloyds declined 1.6 percent to 30.56 pence. The Bloomberg Europe Banks and Financial Services Index fell 4.7 percent as Germany prepared plans to aid banks if Greece defaults.
RBS, Lloyds and Barclays have dropped by more than 50 percent since the ICB’s first report in April. HSBC and Standard Chartered Plc, British banks that earn most of their profit outside Europe, declined by 26 percent and 21 percent over the same period.
While the commission stuck to its argument that Lloyds be forced to sell additional branches beyond the 632 required by European Union regulators, it said the government and the bank should negotiate the details.
A “strong challenger” bank should result, with at least 6 percent of the consumer checking account market. That’s 1.4 percentage points more than Lloyds agreed to sell in 2009 after receiving state aid.
There is “a real danger” that Lloyds’s current asset program “will fall back into the range of small banks that have not exerted a strong competitive constraint in the past,” the report said.
Ring-fenced banks would have an independent board, the report said. Unless the protected part of the bank is the majority of the lender, most directors in the insulated bank should be independent non-executives. The protected lender will make its own disclosures to regulators, it said.
The report also recommended that ringfenced banks hold more capital than required by the Basel Committee on Banking Supervision. The Basel III rules require banks to more 7 percent of risk-weighted assets in core capital, and the biggest lenders, so-called systemically important financial institutions, to hold as much as a further 2.5 percentage points in additional capital.
HSBC Holdings Plc, Barclays, Lloyds, RBS, Santander U.K. Plc and Nationwide Building Society should hold 3 percentage points more capital on top of the 7 percent required by Basel. Co-operative Bank, Clydesdale Bank and the lender that Lloyds is selling should hold 1 percentage point to 3 percentage points more.
The commission’s plan to make the largest U.K. banks hold equity capital of 10 percent of risk-weighted assets “exceeds” Basel’s surcharges for systemically important financial institutions, the report said today.
“The arguments for separating retail banking from global wholesale and investment banking are sound,” said the Investment Management Association, which represents British funds managing over 3.9 trillion pounds of assets on behalf of U.K. and overseas clients. “This is a thoughtful policy approach for protecting taxpayers from the potential damage of another banking blow-up.”
Credit-default swaps on U.K. banks rose to records. Contracts on Barclays Plc’s senior debt climbed 29 basis points to 289, while swaps on Royal Bank of Scotland Group Plc notes increased 22 basis points to 390, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
A basis point on a credit-default swap protecting 10 million euros ($13.6 million) of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.
Creating a firewall “is at best a weak gesture and at worst a pointless act which will not in any material way impact the behavior or culture at the top of the banks where this crisis was born,” said David Fleming, national officer of the Unite trade union, which represents bank workers. “Greedy bankers” will find ways to maneuver around, and lobby against these reforms,” he said.
“The Vickers Report fails to deal with what really needs to be done to transform our banks,” Trades Union Congress General Secretary Brendan Barber told the labor movement’s annual meeting in London today. “Let’s argue for real reform of our financial system, turning the banks from casinos that enrich themselves into utilities that serve us.”
--With assistance from Thomas Penny and Howard Mustoe in London. Editors: Francis Harris, Edward Evans
To contact the reporters on this story: Gonzalo Vina in London at firstname.lastname@example.org; Gavin Finch in London at email@example.com
To contact the editor responsible for this story: Edward Evans at firstname.lastname@example.org