All change in universal banking?

Proposals to separate the retail and investment banking arms of the UK's biggest financial institutions are back on the table. Lucy Mair discusses recent developments

Four years ago this month, the financial crisis rocked the foundations of British banks and the government was forced to prop up Lloyds Banking Group and the Royal Bank of Scotland using taxpayers' cash. Then, when the coalition government came to power in 2010, it appointed an Independent Commission on Banking to consider how the banking system should be reformed to prevent a similar crisis in future.

Its final report, known as the Vickers report after its chair Sir John Vickers, is less than a year old. The government's response to the report, a white paper on banking reform, was delivered just four months ago. But frustration at the slow pace of implementation of the (somewhat watered-down) reforms, which the government says must be in place by 2019, is already beginning to surface.

Sooner, not later

The main recommendations of the Vickers report are as follows. First, the retail operations of large banks should be ring-fenced from their investment banking activities. The goal of separation is to prevent banks that hold deposits from ordinary individuals and small businesses from using their cash to engage in risky transactions. Second, banks should increase their reserve capital to four per cent of the total value of their assets to act as a cushion should another crisis occur. Finally, a series of measures should be introduced to increase competition in the banking sector.

Legislation to separate the retail and investment banking arms of financial institutions is due to be introduced by the coalition government in 2015, though banks would have a further four years to adjust to it. But speaking ahead of the Labour Party conference in Manchester at the beginning of October, Labour leader Ed Miliband threatened that the next Labour government would break up the banks by force if they fail to separate their retail and investment banking activities themselves. In an effort to apply pressure to the City and the present government, he added that serious measures would be needed if universal banks attempt to avoid the Vickers reforms, which are supposed to make them safer.

EU ring-fencing

Meanwhile, earlier this month, the Liikanen commission, an independent review into banking practices in the EU by Finnish central bank chief Erkki Liikanen, recommended that universal banks ring-fence their trading activities, among other reforms. His report calls for Europe's biggest banks, those whose trading assets exceed €100 billion (£807 million) or 15-25 per cent of their total assets, to create a separate entity for their trading activities. This means the trading division would have to hold its own capital and proprietary trading would also be assigned its own legal entity.

In the UK, one of the arguments put forward against the Vickers reforms is that British banks would become less internationally competitive because the ring-fencing of retail activities will reduce the amount of capital they must hold and limit the volume of trading activities that can be profitably financed. EU commissioner Michel Barnier has yet to review the Liikanen recommendations and decide whether to incorporate them into his EU banking reforms, but it nevertheless seems likely that ring-fencing will be the rule, rather than the exception.