DealBook: Britain Backs Banking Overhaul

Rupert Hartley/Bloomberg NewsGeorge Osborne, Britain’s chancellor of the Exchequer, with the 2011 budget.

LONDON — The British government plans stricter banking regulation that would force banks to separate their investment banking operations from those businesses that take deposits.

The chancellor of the Exchequer, George Osborne, said on Monday that the government would seek to pass laws by 2015 to strengthen financial regulation as proposed by an independent commission led by John Vickers, a former Bank of England chief economist. The new laws would then apply by 2019 the latest.

“These are the most far-reaching reforms of British banking in modern history,” Mr. Osborne said in a speech to Parliament. The reforms are intended to allow Britain to stay “home to one of the world’s leading financial centers without exposing British taxpayers to the massive costs of those banks failing.”

The new rules represent a bigger change for the banking industry here than the Dodd-Frank overhaul has meant for banks in the United States, some analysts have argued. Under the British regulation, investment banking and retail banking operations would be different legal entities and financed separately. The rules would also require banks to set aside a slightly bigger capital cushion than required by the Basel III regulations. Only Switzerland has asked its banks to hold more capital to absorb future potential losses so far.

British banks would have to shield deposits of individuals and small and medium-size companies in their consumer bank from investment banking activities, like trading. This means banks would no longer be able to use deposits to finance investment banking units. Investment banking businesses would also be allowed to fail without affecting the rest of the bank. The new rules would not apply to subsidiaries of non-British banks in Britain.

“The face and structure of banking has changed for good, and we’ve reached a point of no return,” Jon Pain, head of financial services risk consulting in Britain at KPMG, said. “Business models need to be fundamentally overhauled.” Major banks should not be “fooled” by the timetable as they “will need to make some serious decisions before June,” he added.

Angela Knight, head of the British Bankers’ Association, played down the impact of the changes, saying that the government’s decision was just “the next stage of a program of reform” and that “banks have already made significant changes to how they operate.”

Some banking executives have argued that the new rules would be expensive for the banks at a time when the industry is already struggling with sluggish growth and volatile markets.

The government, however, has said that banking regulation would have to change after Britain’s securities regulator, the Financial Services Authority, acknowledged that it made mistakes leading up to the financial crisis, when the government had to inject billions of pounds into the banking system.

Mr. Osborne said the reforms were expected to cost the banking industry as much as £8 billion, or $12 billion, as banks would no longer benefit from the perceived guarantee that the government would bail them out. The costs to gross domestic product could amount to as much as £1.8 billion but would be “far outweighed by the benefits,” Mr. Osborne said.

The government asked the Vickers commission last year to come up with proposals of how best to protect taxpayers from having to bail out financial institutions during any future banking crises. Britain’s government spent more than $1 trillion in bailing out ailing financial institutions during the recent financial crisis and still owns stakes in two of the country’s largest banks, Royal Bank of Scotland and the Lloyds Banking Group.

The government said Monday it accepted all the commission’s proposals, which also includes ways to increase competition among local banks and make it easier for customers to switch banks.

Barclays’ chief executive, Robert E. Diamond Jr., has criticized the regulation overhaul, saying the proposals were not the best way to protect depositors and would just burden the banking sector with additional costs. Stephen Hester, the chief executive of Royal Bank of Scotland, has said the new rules would put British banks at a disadvantage to global competitors.

Some banks, including HSBC, have previously said they would consider moving their headquarters abroad if the new regulation was too punishing. Mr. Osborne denied Monday that the rules would make London less attractive as a financial center.

The new banking laws come in addition to changes to the structure of the financial supervisors. David Cameron’s government decided in 2009 to abolish the Financial Services Authority and move most of its supervisory responsibilities to the Bank of England next year.

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