Banking's barbed wire

Lucy Mair looks at how Osborne's electrified ring fence will bolster the UK's banking industry

In early February, chancellor George Osborne announced that the UK's biggest banks will be broken up if they fail to follow new rules and ringfence (that is, separate) their high street banking activities from riskier investment banking operations.

His populist speech, which played on the public's anger at having to bail out Royal Bank of Scotland and Lloyds Banking Group back in 2008, came as the government introduced the Banking Reform Bill to parliament, which aims to increase competition among high street banks.

What's it all about?

The idea of a ringfence to protect the deposits of British individuals and small-businesses from high-risk activities in the investment banking sphere is nothing new.

When the coalition government came to power in May 2010, it appointed the Independent Commission on Banking, led by Sir John Vickers, to consider banking reform. In 2011 Vickers published his findings, which concluded that a ringfence would be the most effective way of protecting retail banks from future investment banking losses.

The Commission also recommended that banks should increase their reserve capital to 4 per cent of the total value of their assets to act as a cushion should another crisis occur. The government accepted the recommendations, and by 2019 banks will have to comply with the new rules.

Electrifying the ringfence

Last year, the Parliamentary Commission on Banking Standards called for stronger regulation in light of scandals such as the mis-selling of payment protection insurance (PPI) and the rigging of the Libor interest rate. It recommended that a reserve power be able to enforce the ringfence and break up universal banks if they failed to play by the new rules.

And the chancellor has now taken those recommendations on board. "My message to the banks is clear: if a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether - full separation, not just ringfence," he said at a speech in Bournemouth. Effectively, this means that any banking group found to be in breach of the rules would be forbidden from having a retail banking arm, and would no longer operate as a universal bank.

Opinions divided

The British Bankers' Association has spoken out against the proposed electrification of the ringfence, criticising the policy because it will make it more difficult for retail banks to lend money to small businesses. This is because separating retail and investment banking operations will limit the volume of trading activities that can be profitably financed, therefore reducing the availability of capital for high street banks to lend.

There are also suggestions that an enforced ringfence could damage the UK's attractiveness as a global financial centre. While other countries are focussing on separating certain risky parts of investment banking activity, the UK is the only place that will separate its high street banks. Tony Anderson, a partner in the banking team at international law firm Pinsent Masons, pointed out that these measures will make it "harder for universal banks with global operations to continue to maintain the same operations in the UK in an already difficult trading environment."

However, chief executive of Lloyds Bank, Antonio Horta-Osorio is firmly in favour of the measures. He told the Banking Standards Committee: "If we think that for society as a whole it is important to have ringfencing, both from a financial stability point of view and from a cultural point of view, I absolutely agree it should have strong enforcement and strong incentives in order for this to happen."

But there is still some way to go before new rules on a stronger ringfence are finalised. Co-head of the Deloitte Centre for Regulatory Strategy, Clifford Smout, said: "How the regulator will monitor compliance and respond to any attempt the breach the ringfence will be important, as will the role of [the] government, who have the final say on whether to force a break-up in any individual case."

It is likely that banks will now lobby the government to try to make the reforms more palatable.