The British government announced its proposals for reform of the U.K. banking industry on Thursday, aiming to prevent a repeat of the crisis which forced taxpayers to bail out two major banks in 2008.
The government said it will legislate to isolate retail banking from riskier investment banking activity. That step was a key recommendation of the Independent Commission on Banking to protect taxpayers from bearing the cost of bank failures and to protect the savings of ordinary depositors.
Business Secretary Vince Cable said the proposals would lead to a situation where "the public do not subsidize banks and banks are allowed to fail without a threat to the system at large."
The Treasury said individual depositors would be compensated before bondholders and corporate creditors in the event of a bank failure. The government already guarantees deposits up to 85,000 pounds ($132,000).
This provision, the government's paper said, "should sharpen the incentives for other senior unsecured creditors to exert discipline on banks' behavior."
Bankers have warned that putting depositors ahead of bondholders and creditors could force up the cost of loans to business and consumers if bondholders demand higher returns on their investments.
Treasury chief George Osborne planned to promote his plans Thursday evening in the annual Mansion House speech to executives and dignitaries of the City of London, Britain's long-established financial district.
"We've got to stop problems here in the City of London spilling onto our high streets and putting taxpayers' money at risk," Osborne will say, according to excerpts released in advance by the Treasury.
Angela Knight, chief executive of the British Bankers' Association, said Wednesday that the industry still has problems with the government's plans.
"Whilst we believe strongly that depositor protection is essential, the depositor preference proposition may work against financial stability and be a turn off for the investors in a bank," Knight said in a speech at a banking conference.
Treasury officials have indicated that the legislation will make some concessions on the activities to be included in the retail side, such as permitting simple tools to hedge against interest rate and currency movements.
Richard Lloyd, executive director of consumer group Which?, welcomed the government's plans to separate retail and investment banking as "a major step towards restoring consumer confidence and transforming the culture of banking."
"Consumers should never again have to foot the bill for a banking bailout that last time cost every man, woman and child 2,000 pounds," Lloyd said.
Osborne set up the Independent Commission on Banking two years ago. The government plans to publish draft legislation later this year and aims for passage before the national election expected in 2015.