"Smaller, quarantined banks" the future for London, says expert

Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, was reacting to comments made by the Chancellor of the Exchequer and the outgoing Governor of the Bank of England at the annual Mansion House dinner, hosted by the Lord Mayor.

Anderson said that "complexity" within the banking sector had moved from the financial instruments in which banks trade to their internal compliance systems, thanks to the UK Government's banking reform programme. The impact this would have on the City's competitiveness as a global banking centre would depend on whether other jurisdictions followed suit, he said.

"When combined with the findings of the Independent Commission on Banking, currently before Parliament under the Banking Reform Bill, these are radical steps for London to take as a global banking centre. Smaller, quarantined banks with significantly more complex compliance systems - but will other jurisdictions follow? This is the real issue," he said.

If enacted in its current form, the Banking Reform Bill will 'ring-fence' retail banking activities from a wider banking group's riskier investment activities. Ring-fenced banks will need to be legally and operationally distinct entities from non ring-fenced banks, and will not be able to hold or own the capital of other non ring-fenced entities within the group. The Bill is expected to be approved later this year, and banks will have until 2019 to comply with the ring-fencing requirement.

As part of his speech, Chancellor of the Exchequer George Osborne discussed the Government's latest thinking on the return of the partly state-owned banks Lloyds and RBS to the private sector. The Government was "actively considering options" for selling the public's 39% stake in Lloyds, he said, although the recovery of the 81% state-owned RBS is still "some way off".

Osborne said that the Government would "urgently investigate" the case for splitting RBS into a state-owned 'bad' bank, including assets in Ulster Bank and UK commercial real estate, and a retail bank that could be returned to the private sector. It would only take this action if doing so would "accelerate the path back to private ownership', deliver benefits for the wider economy and be in the interests of taxpayers, he said. Following a Treasury review, the Government would decide on a course of action this autumn, he said.

In his speech, departing Bank of England Governor Sir Mervyn King said that banking regulator the Prudential Regulation Authority (PRA) was taking "firm pre-emptive action" (7-page / 37KB PDF) in relation to a reported £25 billion capital shortfall by the UK's eight largest banks. This shortfall is set out in analysis published by the PRA today, based on "more prudent estimates" of expected losses and relative risk (1-page / 67KB PDF) as recommended by the Bank of England's Financial Policy Committee (FPC) in March. King said that each of the banks "have plans for actions to fill that shortfall".

From next year, the FPC and PRA will work together to conduct regular 'stress tests' of UK banks, ensuring that any capital shortfall is identified early, King said. The results of these tests are intended to be public, and banks will be expected to set out their plans for making up any shortfalls identified by the tests.

However, King said that the higher capital standards would not necessarily prevent banks from lending to businesses.

"Those who argue that requiring higher levels of capital will necessarily restrict lending are wrong," he said. "The reverse is true. It is insufficient capital that restricts lending ... Capital supports lending and provides resilience. And, without a resilient banking system, it will be difficult to sustain a recovery."

In their respective speeches, both Osborne and King praised the work of the Parliamentary Commission on Banking Standards (PCBS), which published its final recommendations for reform of the professional culture and standards of the UK banking industry yesterday. In its report, the PCBS recommended the creation of a new regime, backed by potential criminal sanctions, in which senior bankers became "personally responsible" for bank failures. It also recommended a reformed system of governance and stronger enforcement powers for market regulators.

Osborne said that the Government would respond to the "very impressive" report fully next month, but said that it supported criminal sanctions for bankers and the ability to cancel bonuses if a bank needed to be 'bailed out' by the taxpayer.

"Let me be clear: where legislation is needed, the Banking Bill currently before Parliament will be amended to ensure the recommendations can be quickly enacted," he said.