The British government intends to force banks to separate their retail operations from their more volatile investment banking, and it is putting up for sale the first bank nationalized during the credit crisis, the nation's Treasury chief said Wednesday.
George Osborne endorsed the principle of insulating retail banking from other bank activities, but said he was waiting for the final report of the Independent Commission on Banking to flesh out the details.
The move is intended to help prevent a repeat of the financial crisis of 2008 and to keep banks from becoming too big to be allowed to fail.
Even before Osborne spoke to a gathering of financial executives, bank shares tumbled lower following reports of his decision.
"All banks should be allowed to fail safely without affecting vital banking services," Osborne said, "without imposing costs on the taxpayer."
He also announced that the government is preparing to sell nationalized mortgage lender Northern Rock, the first British casualty of the credit crisis.
Shares in Britain's big banks fell Wednesday, with Barclays down 2.7 percent at the close, while bailed-out Royal Bank of Scotland and Lloyds Banking Group fell 1.9 percent and 1.8 percent, respectively. HSBC was also down 1.2 percent.
Osborne said the government hopes to find a single buyer who will pay 1 billion pounds ($1.6 billion) for Northern Rock, which has been restructured and is still not profitable. The government has siphoned off Northern Rock's most toxic assets into a "bad bank" and is in the process of liquidating them.
The Independent Commission on Banking, chaired by Sir John Vickers, a former chief economist of the Bank of England, has recommended a clear separation of retail and investment banking; details of the commission's proposal are expected in a final report on Sept. 12.
In his interim report in April, Vickers said that "ring-fencing" retail banking would make it easier and less costly to sort out a crisis. This would allow retail operations including current accounts, consumer loans and mortgages to continue, while the investment side could be allowed to fail.
Vickers said the split, along with higher capital requirements on the retail side, "could curtail taxpayer exposure and thereby sharpen commercial disciplines on risk taking."
Bruce Packard, analyst at Seymour Pierce, said the success of the plan depends on whether investors believe any of the big banks' investment arms would be allowed to fail.
If so, Packard said, "they should impose much greater discipline on these divisions. If the idea works, it would make the whole sector more resilient in a crisis, and a more investable proposition for equity investors."
Bankers have been divided in their reaction to the proposals.
Stephen Hester, chief executive of Royal Bank of Scotland, recently told a parliamentary committee that ring-fending could backfire by creating "a protected beast that the government would support," inadvertently encouraging excessive risk-taking on the retail side.
Hester added that the removal of implicit government support would also make other parts of the bank more exposed.
RBS and Barclays favor a limited ring-fencing which only covers retail deposits, while HSBC Chairman Douglas Flint recommended that the retail side should include some corporate deposits and loans.