UK Backs Banks' Ring-Fencing And Northern Rock Sale

By Sudip Kar-Gupta and Fiona Shaikh

LONDON 

(Reuters) - Britain fired the starting gun on major reforms for its powerful banking sector, backing calls to ring-fence banks' retail businesses from their investment banking activities to shield taxpayers from future crises.

On Wednesday, Chancellor George Osborne supported the Independent Commission on Banking's ring-fencing proposal, in a move aimed at showing the public that the coalition government is fulfilling its promise to be tough on the banks.

Osborne added he wanted to find a buyer for Northern Rock -- a bank that nearly collapsed and was fully nationalised during the credit crisis -- by the end of the year.

The ring-fencing would set up safety barriers between retail and investment banking arms, while keeping the different divisions under the same parent holding company. Osborne also backed higher capital ratios for the banks.

The reforms go further than measures in other countries, although the capital requirements are unlikely to be as tough as in Switzerland. The ICB has proposed that top retail banks hold a core tier one capital ratio of at least 10 percent.

But full specifics of the plan, which aims to shield retail depositors and ensure taxpayers do not have to bail out the industry in any future crisis by creating much larger capital cushions, have not yet been finalised.

"Retail ring-fencing would not be our first option, but we can see ways it would work, though clearly there's a lot more work to do on the details and the specifics," Barclays Chief Executive Bob Diamond said.

Under the plan, domestic banking would become a low-risk utility service, while riskier investment banking -- dubbed "casino banking" -- will face higher funding costs, potentially forcing some companies to shrink or reshape.

"It's yet more regulation that they're going to have to deal with, which will impact their profitability," said Ion-Marc Valahu, fund manager at Geneva-based ClairInvest, which owns Barclays bonds.

Some had expected the proposals to be more severe. Industry analysts said the banks were unlikely to follow through on threats to leave Britain in favour of less strict regulatory regimes.

Shares of the "Big Four" banks - Lloyds, HSBC, Barclays and Royal Bank of Scotland -- all closed lower. Barclays fell 2.7 percent, RBS and Lloyds lost around 2 percent, while HSBC slipped 1.2 percent.

NORTHERN ROCK SALE

Britain set up the ICB last year to examine reforming a sector that was badly burnt during the crisis and in many instance received taxpayer bailouts.

Osborne started a sale timetable for Northern Rock, which had to be nationalised three years ago after becoming the first major British bank in more than 150 years to suffer a run on its customer deposits as the credit crisis began to bite.

Analysts have said Virgin Money, supermarket retailer Tesco's banking arm and private equity firm JC Flowers may bid for Northern Rock, while mutually owned savings companies such as Coventry Building Society have also expressed interest.

The Northern Rock sale is part of a broader push to boost competition in a banking market dominated by Lloyds, Barclays, RBS and HSBC.

The crisis also led to Britain bailing out Lloyds and RBS. The government finished with stakes of 41 percent and 83 percent respectively in those two banks, and Osborne said it could still take some time before Britain sold its RBS and Lloyds stakes.

"It will take some time -- possibly several years -- before we can sell them all," he said.

RING-FENCE DETAILS

Osborne did not provide details of what assets should be ring-fenced, but he made clear that the separation should allow the retail arm to keep functioning if investment banking operations are wound down.

Full details of the planned ring-fencing reforms and other proposals will not be released by the ICB until September 12, and banks and analysts said more details were needed to assess the impact and cost.

The ICB, which has stopped short of recommending a full break-up of the banks, expects the ring-fence to be introduced alongside other reforms, such as detailed plans to allow an orderly wind-down of a lender when it hits trouble.

The suggested minimum capital requirements for UK banks may be similar to those imposed on overseas rivals as big global banks face a top-up requirement over the current 7 percent global minimum standard.

The plan allows the Conservative-Liberal Democrat coalition to address public anger against the banks by showing taxpayers that the banks are being reformed, while not overly harming Britain's competitive position.

The ICB said the costs of the process "may be material" but would fall far short of one estimate of 12 billion pounds.

The top banks are split over how ring-fencing would work. HSBC and Lloyds favour a broad ring-fence including far more assets than a set-up supported by Barclays and RBS.

HSBC last week told lawmakers that all banking book assets should go behind the ring-fence, which would include mortgages, corporate loans and all long-term assets it holds being protected by a government guarantee.

It fears a narrow retail ring-fence would have far more deposits than loans, leaving its investment banking business needing to raise more costly funds in wholesale markets.

But RBS Chief Executive Stephen Hester warned that the plans raised an element of moral hazard, as banks could make riskier loans knowing they were covered by a state guarantee.

(Additional reporting by Christina Fincher, Sinead Cruise and Steve Slater; Editing by Hans Peters,Alexander Smith, Will Waterman and Steve Orlofsky)

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