A British commission recommended Monday that banks should be reorganized so that firewalls protect retail operations from investment banking, an attempt to shield taxpayers from the sector's risk-taking without forcing the banks to split up.
The preliminary report from the Independent Commission on Banking aims to avoid another catastrophic failure of a financial system dominated by a few large banks too big to be allowed to fail.
The commission, which will make final recommendations in September, said it was considering "forms of retail ring-fencing under which retail banking operations would be carried out by a separate subsidiary within a wider group," which would still allow some capital transfers within the organization.
The report also called for part-nationalized Lloyds Banking Group PLC, which has a dominant position in retail banking with more than 30 percent of U.K. current accounts, to dispose of more branches beyond the 600 required by the European Commission.
Sir John Vickers, the commission's chairman, told the British Broadcasting Corp. that the hastily arranged takeover which created Lloyds Banking Group during the financial crisis "was certainly not good for competition and it turned out to be bad for financial stability as well."
Lloyds, 41 percent owned by taxpayers, had no immediate response except that it was "assessing the full implications of the report."
Nevertheless, the market response appeared to be positive, with Lloyds shares up 1.8 percent at 63.27 pence in early trading.
Shares in Barclays PLC and Royal Bank of Scotland PLC, which have large investment units, were up strongly too on relief that the commission did not call for more drastic remedies, such as splitting off the investment banking divisions from the retail side.
The commission called for banks to hold more capital than the 7 percent ratio of equity to risk-weighted assets set in the Basel III agreement
The commission said a forced break-up of banks would be costly and could lose some of the benefits of universal banking.
"We believe that you can get adequate protection of the retail side with lower cost to the system as a whole with the retail ring fence idea," Vickers said.
The report said retail customers have no real alternatives to their banks for essential financial services, "hence the imperative to avert disruption to the system for their continuous provision."
The commission said a method for insulating retail banking from wholesale and investment banking "could take various forms."
Barclays' share price was up 3.6 percent at 307.95 pence, while RBS' rose 3.1 percent to 44.77 pence.
"Taking the perspective of the average consumer, the interim report would appear to be somewhat disappointing," said Keith Bowman, analyst at Hargreaves Lansdown Stockbrokers.
"Rising financial capital cushions are likely to be paid for by increased banking charges, whilst the rise of an army of new alternative banks still looks to be a lifetime away. Furthermore, with U.K. buyers of Lloyd's surplus branches likely to be few and far between, tax revenues from those operations could soon be winging their way overseas," Bowman said.
The British Bankers Association did not react to specific proposals, but said the commission's report would have to be considered in the context of reforms already under way in national and international regulation.
"Banks in the U.K. have already undergone significant change since the global crisis, including significantly increasing their capital and liquidity and establishing resolution plans, to protect depositors and to keep finance flowing, should a bank get into difficulty," the association said.