Parliamentary commission calls for stronger “electrified” fence between banks’ retail and investment arms

Plans to protect banks’ deposit-taking operations from their riskier investment activities may not be tough enough to prevent another financial crisis, according to a report that today calls for an “electrified” ringfence.

The first report from the Parliamentary Commission on Banking Standards, set up in July after Barclays was fined £290 million for manipulating the London interbank offered rate (Libor), said banks must be structured in such a way that would allow them to fail without wreaking havoc on the wider economy.

Andrew Tyrie, the Conservative MP who chairs the commission, said: “The latest revelations of collusion, corruption and market-rigging beggar belief. It is the clearest illustration yet that a great deal more needs to be done to restore standards in banking.”

While the commission supported the creation of a ringfence between retail and investment banking operations, they warned the current proposals did not go far enough and regulators should be given the power to break up banks that try to circumvent the rules.

Today’s report says: “Additional powers are essential to provide adequate incentives for the banks to comply not just with the rules of the ringfence, but also with their spirit.

“In the absence of the commission’s legislative proposals to electrify the ringfence, the risk that the ringfence will eventually fail will be much higher.”

Tyrie says that the proposals, as they stand, fall well short of what is required. “Over time, the ring-fence will be tested and challenged by the banks. Politicians, too, could succumb to lobbying from banks and others, adding to pressure to put holes in the ring-fence.

“For the ring-fence to succeed, banks need to be discouraged from gaming the rules. All history tells us they will do this unless incentivised not to.

“That’s why we recommend electrification. The legislation needs to set out a reserve power for separation; the regulator needs to know he can use it.

“Furthermore, we need periodic reviews of the sector to reassure us that the ring-fence as a whole is working. Tougher measures may yet be required.”

According to the Treasury, the cost to banks of separating their retail and investment arms could run at between £1.7 billion and £4.4bn a year, with one-off “transitional” costs of up to £2.5bn, although the commission notes that some witnesses who gave evidence argued that the final figures could be higher.

However, the costs are far lower than the government has spent propping up the banking sector since the financial crisis erupted in 2007. Treasury figures show the outstanding taxpayer support stood at £228bn as of March 2012, down from a peak of £1.2 trillion.

During his appearance before the commission, Lloyds chief executive Antonio Horta-Osorio said that ring-fencing “enhances the credibility of recovery and resolution mechanisms because it provides…a separation between retail and investment banking”.

Barclays chief executive Antony Jenkins – who replaced Bob Diamond following the Libor scandal – said banks should be able to separate their retail and investment operations without affecting their ability to lend.

However, other banks were less certain, with RBS chief executive Stephen Hester telling parliamentarians that he did not believe the move would produce “any safety benefits to the financial system or the UK”, while Peter Sands, chief executive of Standard Chartered, argued that “it will not deliver a stability benefit, and it will be more expensive”.

Next year the commission will look at areas such as competition, corporate governance and role of civil and criminal law in enhancing banking standards, and Tyrie said: “It is essential that banks are restructured in such a way that allows them to fail, whether inside or outside the ringfence.”