Ring-fencing banks could create more risk, warns RBS chief Stephen Hester

RING-fencing different banking operations may backfire by making UK retail banks too adventurous in their lending, the boss of the taxpayer-backed Royal Bank of Scotland has warned.

Stephen Hester, RBS's chief executive, told MPs he did not oppose the principle of some sort of ring-fencing of riskier investment banking from retail banking recommended in the recent interm report of the Independent Commission on Banking (ICB).

But he told the Treasury select committee it risked triggering "moral hazard" – banks lending in too cavalier a fashion in the knowledge they will be bailed out by the taxpayer or the authorities.

Mr Hester cited the collapse of Northern Rock and Bradford & Bingley, and the difficulties faced by the Irish banks and the Spanish "caja" regional banks, whereby a perceived taxpayer guarantee allowed them to go on a spree with cheap money.

"We have to worry about moral hazard," Mr Hester said. "Ringfencing can be another form of moral hazard. We are saying anything within this we will protect."

Mr Hester said he had no objection in principle to some form of split of retail banking from investment banking, stopping short of a full break-up, as long as it was implemented properly.

But he added that it was vital the ICB, which issues its final report in September, did not unwittingly add to the systemic risk in the UK banking system rather than cut it.

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He said it was essential that in any partial split there was "absolutely no room" for retail banks to cause later systemic problems.

RBS, which is 83 per cent owned by the taxpayer after a 45 billion state bailout, "lost significantly more money in loan impairments (bad debt charges] than it did in investment banking", Mr Hester said. "It's a real mistake to attribute losses to one particular type of activity."

Most of the risk that "exploded in people's faces" in the financial sector's near-collapse had been down to domestic lending, he said, citing the experience at the likes of Northern Rock and Dunfermline Building Society.

Elsewhere, Mr Hester also conceded there could have been some "leakage" from taxpayer support into the bonus pool.

Mr Hester confirmed earlier claims by ICB chairman Sir John Vickers that money from the taxpayer-funded bailout may have been used to pay bankers' bonuses.

Douglas Flint, the Scots-born chairman of HSBC, was more receptive to the ring-fencing proposal. He called the impact on the supply of credit to the real economy from the financial sector's implosion "tragic". He said of ring-fencing: "It's required. The main responsibility should be to ensure the supply of credit to the economy is uninterrupted by volatile conditions."

Antonio Horta-Osorio, who on 1 March became chief executive of Lloyds Banking Group, owner of Bank of Scotland and Scottish Widows, said ring-fencing would "protect key functions and reduce complexity".

He said so-called universal banks, which do both investment and retail banking, could still retain the benefits of diversification at holding-company level and that there had to be a trade-off between the costs of the exercise to banks and "the benefits to society".