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Banks have until 2019 to separate retail and investment banking activities, says ICB

Banks taking customer deposits and providing overdrafts will have to do so separately from their commercial and investment activities, according to bank reform plans proposed to the Government.

Chancellor George Osborne has previously said he will act on plans produced by the Independent Commission on Banking (ICB) and will tell Parliament later today which of its recommendations the Government will adopt.

'Ring fencing' retail activities to a separate subsidiary of a larger bank will "isolate those banking activities where continuous provision of service is vital to the economy", the ICB said in its final report (363-page / 1.9 MB PDF).

However banks will have until the Basel III international banking agreement comes into force in 2019 to fully implement the reforms.

Banking law specialist Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, suggested the Government should delay the reforms "until the economy is better able to digest them".

The ICB was set up by the Government last year to come up with ways to make UK banking safer and more competitive, and to look at the possibility of structural reform.

Under its proposals retail banking activities must be provided by a separate subsidiary of a wider banking group which will be legally, economically and operationally distinct. The subsidiary will have "distinct governance arrangements" and should have a "different culture" from the rest of the group, the report said.

The retail subsidiary will need to meet regulatory requirements independently and its relationship with other parts of the group conducted on an "arm's length basis", the report said. Any transactions with the wider group will need to conform to the same regulatory requirements as transactions with third parties.

Taking payments from and providing overdrafts to individual customers and small and medium-sized businesses should be within the ring fence, the report said. 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.

Some flexibility in providing lending services to large companies will be allowed under the plans.

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

The ICB report contained other proposals which it said will make banks better able to withstand temporary cash flow problems and which go further than previous arrangements.

Under the international banking agreement known as Basel III, banks will have to have equity capital of at least 7% of risk-weighted assets by 2019.

However the ICB recommended that large UK retail banks should have equity capital of at least 10% of risk-weighted assets, exceeding the Basel III minimum. This means that for every £10 banks lend out, they must hold £1 in reserve against potential losses.

Pinsent Masons's Anderson urged the Government to consider the reaction of other jurisdictions before taking action on any reforms.

"The UK is the first Eurozone member to introduce significant reforms of its domestic banking market following the crisis," he said. "The ongoing reaction of the markets to these proposals, whether other jurisdictions follow suit and whether they ultimately position London as a financial safe haven are the big questions. The Government would be wise to delay any reforms until the economy is better able to digest them."

Trade body the British Bankers' Association, which previously warned against the application of "uncosted" proposals, echoed Anderson's comments. It said in a statement that UK banks were already well on the way to implementing "sweeping reforms" expected by the EU and international banking community.

"Any further reform measures adopted by the UK authorities need to be carefully analysed and compared with those agreed internationally. It is vital that the full impact any further reforms will have on the economy, the recovery and banks' ability to support their customers in the UK in understood," it said.

The Treasury described the ICB report as "impressive" ahead of a full statement to Parliament from Chancellor George Osborne this afternoon.

"The Government welcomes the final report of the Independent Commission on Banking. It is an impressive report and an important step towards a new banking system that supports lending to businesses and families, supports the economy and jobs but doesn't cost the taxpayer billions of pounds when it goes wrong," a spokesperson said.

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