Government sets out plans for banking reform

By Michael Millar

Date: Thursday 14 Jun 2012

The government has detailed how it plans to split retail and investment banking, including increased protection for depositors over other creditors.

The White Paper, which lays out how the government will implement the recommendations of the Independent Commission on Banking (ICB), is designed to make banks more resilient and simpler to wind up if they fail.

Financial Secretary Mark Hoban unveiled it, confirming retail banking would be ring-fenced from riskier operations such as investment banking.

"A ring-fenced bank will be economically and legally separate from the rest of the group and run by an independent board," Mr Hoban told the House of Commons.

Ordinary account holders will receive 'depositor preference' over other creditors, such as bondholders.

"Changing the creditor hierarchy, as far as permitted by EU legislation, so that deposits entitled to protection [under the Financial Services Compensation Scheme] are preferred...in insolvency should sharpen the incentives for other senior unsecured creditors to exert discipline on banks’ behaviour," the White Paper says.

Banks had railed against this, saying giving creditors such as bondholders less protection would mean increased costs for the banks due to the higher risk premium.

But the government has made concessions to the banking sector, which had also argued furiously that splitting operations would make banking services more expensive.

The government said a wider range of activities would be allowed within ring-fenced operations than envisaged by the ICB.

These include certain hedging tools, for example to protect against interest rate and currency fluctuations, where these are sold alongside loans to small business clients.

"We felt that it was in the interests of business to ensure there was a wider range of instruments included in the ring-fence, including derivatives," Hoban said.

"These products are widely used. There is a need for them."

The government also watered down plans to make UK banks hold more capital than their international rivals.

UK banks will be expected to hold capital equivalent to 3% of their loans and investments, compared to a 4% level recommended by the ICB.

In his annual Mansion House speech in the City tonight, Chancellor George Osborne will call the measures a "fundamental reforming the structure of our banking sector".

"We’ve got to stop problems here in the City of London spilling onto our high streets and putting taxpayers’ money at risk," he will say.

The new plans would see banks turning to their creditors for a 'bail in', rather than a bail-out from the public if they get into trouble.

"This means that creditors do not obtain financial rewards without being appropriately exposed to the corresponding risks," the White Paper says.

'For the bail-in tool to achieve these goals, creditors need to believe that they may be required to take losses when a bank fails," it adds.

"The government expects that creditors would demand a higher return to compensate for the loss of the perceived implicit public subsidy."

The aim is to introduce legislation "as soon as Parliamentary time allows", and the government said it was committed to completing all primary and secondary legislation by the end of this Parliament in May 2015.

Banks would have to comply with all of the measures proposed by 2019, as recommend by the ICB, it added.

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