Government will legislate for retail and investment bank ring fencing by 2015, Osborne says

In a statement to Parliament, George Osborne said that a white paper outlining how the Government will implement reforms proposed by the Independent Commission on Banking (ICB) earlier this year will be published next spring. Necessary legislation will go through Parliament before the 2015 election - ahead of the 2019 deadline proposed by ICB chair Sir John Vickers, he said.

Banks will be expected to comply with the new laws "as soon as practically possible thereafter", but the Government would work with the banks to develop a reasonable transition timetable, he said.

However, the Treasury has backed down on Vickers' proposal that the biggest UK banks should hold enough risk-adjusted assets to cope with losses equivalent to around a fifth of the size of their balance sheets.

Banking law expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said that international banks including HSBC and Standard Chartered had lobbied for this change to the ICB's proposals due to their global operations being much larger than their UK operations. Requiring these banks to hold 20% of their total balance sheets as liquid assets would force them to raise huge amounts of additional capital or loans, he explained.

"In addition, HSBC has highlighted that its lower reliance on unsecured borrowings would have made the original recommendations disproportionately expensive for them in comparison to other UK banks," he said.

Instead, the Government will exempt big banks from holding additional capital relating to the areas of their balance sheets which do not propose a threat to the UK taxpayer," Osborne said.

The aggregate cost to UK banks of implementing the ring fence proposals will be between £3.5bn and £8bn. Osborne said this was "broadly in line" with the ICB's estimates.

The ICB was set up by the Government last year to come up with ways to make UK banking safer and more competitive following the 2008 financial crisis. In its final report (363-page / 1.9MB PDF), published in September, it recommended that retail banking activities be provided by a separate subsidiary of a wider banking group which should be legally, economically and operationally distinct from the group's investment banking activities.

Taking payments from and providing overdrafts to individual customers and small and medium-sized businesses will be included within this ring fence. Any services not "integral to the provision of payments services to customers in the European Economic Area" or that would expose the ring-fenced bank to international financial markets should not be included. This will cover providing banking services to non-European customers and 'trading book' activities, such as purchasing loans or securities and derivatives trading.

The aggregate balance sheet of UK banks is currently over £6 trillion, according to ICB figures. Between one-sixth and one-third of this will be covered by the retail ring fence.

Osborne said that the Government would invite opinion on whether to proceed with an exemption from the ring fence requirement for "small banks that were clearly not systemic".

The ICB also proposed that large UK retail banks should hold tier one capital assets of at least 10% of their risk-weighted assets, meaning that for every £10 that banks lend out they must hold £1 in reserve against potential losses. This is stricter than the level proposed under the international banking agreement known as Basel III, which provides that banks have equity capital of at least 7% of their assets adjusted for risk by 2019. Tier one capital consists in the main of shareholders' equity and disclosed reserves.

"It is good news for the UK Government that the EU has now indicated that it will not impede the UK introducing higher regulatory capital requirements than that required by Basel III. There must still be concern, however, about the cost of implementing the reforms and what this will do to the UK banking landscape," said banking law specialist Anderson, who said that the estimated cost of ring fencing had "varied widely" between different banks depending on their operations.

"Barclays announced to the Treasury Select Committee last week that its implementation costs could approach £2bn with the majority of this being 'felt' in its investment banking operations. More worrying for the Government, and the City, is [chief executive] Bob Diamond's indication that whilst Barclays would continue to be domiciled and regulated in the UK, it could relocate [investment banking division] Barclays Capital to either Asia or New York," Anderson said.

Addressing the Committee last week on the impact of the changes, Diamond said that the impact on Barclays would be "negative". However, he stressed that the lender could "manage" the increased burden.

Diamond added that there were some "challenges" that came with the bank's UK base but concluded that "we have been in the United Kingdom for 320 years; this is where we want to be".

The Treasury also confirmed that steps would be taken to make it simpler for customers to switch bank accounts. The ICB report called for a free current account redirection service to be formed by September 2013, including an automated system to catch all credits and debits going to a closed account.

The Chancellor also announced a major reduction in the size and scope of the investment bank arm of the taxpayer-owned Royal Bank of Scotland (RBS), following a report into the bank's new collapse by the Financial Services Authority (FSA) earlier this month.