Schumpeter | Bank reform and Britain's economy

A ring-fence round the high-street banks

Britain moves to adopt tough new rules on banks

By J.O.

IN BRITISH politics, independent commissions are often a diversion that allows governments to be seen to be doing something about a difficult issue. Sometimes their findings are respectfully ignored. So it was a mild surprise when on June 15th, three months before the Independent Commission on Banks (ICB) is due to release its final report, George Osborne, the chancellor of the exchequer, told the City's annual Mansion House dinner that he would endorse the commission's main findings.

The ICB's most radical idea, set out in its interim report in April, is to force British banks to ring-fence their retail-banking arms into separately capitalised subsidiaries, which can then be salvaged if the rest of the bank goes bust. The banks' trading and investment-banking divisions would, it is hoped, be allowed to live or die without any help from the government.

The commissioners are busily working out where to draw the line dividing retail banking from the riskier kind. For instance, retail banks often help small companies hedge their currency exposures, a service also provided by their investment-banking arms. The changes would increase the borrowing costs of banks by ending cross-subsidies between their different parts, but no one, including the commission, is quite sure by how much.

The ICB's other headline proposal is that large British banks would have to hold bigger buffers against losses than currently proposed under Basel 3, a new international agreement on minimum capital requirements. Mr Osborne said the European Union should adopt these new Basel standards in full, a call echoed by Mervyn King, the Bank of England's governor, who was speaking at the same event. But both speakers said the EU should allow countries to set higher capital standards if national circumstances required them. Varying such rules is a key part of “macroprudential” regulation to be run by the Bank's new financial-policy committee, which has its inaugural meeting on June 16th.

Mr Osborne did his best to sound upbeat about the economy: take out the shrinking financial sector and it had grown by 4% since the recovery began, he said. But he acknowledged that a hard road had been made harder by the rise in oil prices and the disruption caused by the tsunami in Japan. Mr King was blunter: the economy, he reckoned, had grown by only around 1% in the past year. He also implied that interest rates could only rise in earnest once the banks were in better shape.

What prompted Mr Osborne to back the commission so soon? Perhaps it was a concern that the ICB might yet come up with something more radical, such as breaking up the banks altogether, if he dallied. The chancellor also announced that Northern Rock, a mortgage-lender that was nationalised in 2008. is to be sold by the government later this year. That suggests a different motive: a desire to end uncertainty and to draw a line under the banking crisis.

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