Ringfencing's economic impact 'not likely to be vast' but profitability could be affected, report says

However shareholders could instead bear the brunt of any increase in banks' running costs according to Tony Anderson, a banking specialist with Pinsent Masons, the law firm behind Out-Law.com. This would be of particular concern if those banks had been bailed out by public funds, he said.

According to a report from Ernst & Young's economic forecasting group the ITEM Club the likely effect of the Independent Commission on Banking's 'ring fence' proposal "isn't likely to be vast". It will be a slight reduction in the overall economy of 0.3%, it said.

While borrowing costs for large companies could "rise substantially" according to the report, the affected loans represent "less than 25% of overall lending".

Large businesses also have access to alternative sources of funding and can borrow from foreign banks, the report said.

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. It is set to publish its final recommendations to the Government on 12 September.

In its interim report, published in April, the ICB suggested separating retail and investment banking operations. This 'ring fencing' would make it easier to protect customers against investment banking losses, by allowing different parts of a bank to be treated in different ways if they got into difficulty.

Trade body the British Bankers' Association warned last week that the "uncosted" proposals could seriously damage the UK's economic recovery.

The ITEM club suggested that the banks would be unable to pass any costs of compliance onto their customers, but suggested that the knock-on effect of losing the custom of large businesses to foreign markets "would have further implications for the long-term competitiveness and profitability of the UK banking sector".

Banking specialist Tony Anderson warned that this would lead to a reduction in share value - which would be of particular concern if those banks had been bailed out by public funds. "Even if the banks are unwilling or unable to pass on the higher cost of their own borrowings to customers, the resultant effect on bank profitability and share value will be of concern particularly given the current ownership of Lloyds and RBS," he said.

He pointed out that conjecture surrounding the likely effect of the ICB's recommendations is already having a negative impact on share prices.

"The effect of the reforms will depend on what the economy looks like at the point when they come into force. The Government is now saying it will delay any changes until 2015. Banks may have already been split or have siphoned off non-core operations," he said.

"It also depends on what other jurisdictions choose to do as more regulation and higher costs could make the UK look less attractive to investors."