British banks need to ring-fence their retail operations from investment bank activities, the Independent Commission on Banking said yesterday, in a report aimed at preventing more state bailouts.

The ICB, launched last year in the wake of the global financial crisis, also proposed raising capital requirements and recommended that state-rescued Lloyds Banking Group should sell off more assets to boost competition.

“The Commission is considering forms of retail ring-fencing under which retail banking operations would be carried out by a separate subsidiary within a wider group,” the ICB said in a provisional report.

“This would require universal banks to maintain minimum capital ratios and loss-absorbing debt for their UK retail banking operations, as well as for their businesses as a whole.

“Subject to that, the banks could transfer capital between their UK retail and other banking activities.”

Britain’s Conservative-Liberal Democrat government formed the Commission last year, shortly after the coalition rose to power in May, sparking speculation it could force a drastic overhaul of the sector.

However, the eagerly-awaited review did not call for banks to be broken up completely, opting instead for the so-called “ring-fencing” that would not allow investment banking losses to threaten the safety of retail operations.

The ICB report is aimed at safeguarding savers’ deposits and protecting the state from bailing out more financial institutions.

“Banks ought to face market disciplines without any prospect of taxpayer support, but systemically important banks have had and still enjoyed some degree of taxpayer support. This is the ‘too big to fail’ problem,” it said.

“Unless contained, it gives the banks concerned an unwarranted competitive advantage over other institutions, and will encourage much more risk-taking once market conditions normalise.”

The ICB added that banks should raise capital ratios to “at least” 10.0 per cent, significantly more than the seven per cent required by 2018 under new international “Basel III” rules that were agreed in September.

“We believe that you can get adequate protection of the retail side with lower cost to the system as a whole with the retail ring-fence idea,” ICB chairman Sir John Vickers told BBC Radio 4.

He added that the findings were a “moderate combination of the strategies rather than maxing out on total structural separation or indeed maxing out on super-high capital requirements.”

Many of Britain’s banks were ravaged by the global financial crisis, resulting in the nationalisation of Northern Rock and multi-billion-pound rescues of Royal Bank of Scotland and Lloyds Banking Group.

The taxpayer now owns 83 per cent of RBS and 41 per cent of rival Lloyds, while Northern Rock remains in public ownership.

The ICB also criticised the previous Labour government for allowing Lloyds to buy struggling rival HBOS at the height of the financial crisis. The group now has a huge 30 per cent slice of all current accounts in Britain.

Lloyds was ravaged by its 2008 takeover of Halifax Bank of Scotland (HBOS), which was saddled with toxic or high-risk investments in the property sector.

“At the height of the crisis in 2008, Lloyds was allowed, contrary to the normal takeover rules, to acquire HBOS,” Vickers added.

“This was certainly not good for competition and it turned out to be bad for financial stability as well, because the HBOS problems infected the much larger Lloyds group.” In order to address competition concerns, Lloyds has already been forced to sell 600 branches by the European Commission.

However, the IBC argued yesterday that the group needed to sell off more assets. “An enhanced divestiture could give an improved outcome for competition, both by reducing market concentration and by strengthening the divestiture’s ability to act as a challenger. “These competitive pressures should lead to improved prices, products and choice for customers, and to greater efficiency and innovation in the long run,” the report said.

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