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11 April 2011
Last updated at 03:43 ET
UK banks' retail operations should be "ring-fenced" from their investment banking arms, the Independent Commission on Banking has recommended.
However, in its interim report the commission stopped short of recommending the two should operate as separate entities.
It said more competition was needed in retail banking, including the sell-off of more Lloyds branches.
The commission's final recommendations will be published in September.
The banking commission was set up by the government last June to review UK banks after the financial crisis.
Bank shares reacted positively to the report, with Barclays and Royal Bank of Scotland rising about 3% in early trading
Cash reserves The report said that, in the build-up to the crisis, lenders and borrowers took on "excessive and ill-understood risks".
Continue reading the main story “Start Quote
It added that implicit taxpayer support for the banks encourages "too much risk taking".
The commission said that banks needed to hold more cash in reserve to protect against future crises, and that creditors, not taxpayers, should be liable for any losses.
The report recommended that banks should have 10% of their capital set aside to cover potential losses, higher than the 7% set out in new European regulations.
It said it was looking at forms of "retail ring-fencing" under which retail banking would would be carried out by a separate subsidiary within a wider banking group.
'Allowed to fail'
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Sir John Vickers, chairman of the commission, told the BBC that "total separation [of retail and investment banking] is not necessary".
"UK retail banking can be protected by its own capital cushion. Other parts of the bank should be allowed to fail."
This would lead to additional costs to the banks, some of which would fall on the wider economy, he said.
"The cost of capital is going to go up", Sir John said, but the costs to investment banks would be greater than those to retail banks.
Without an implicit government guarantee, which banks currently enjoy, lenders would view investment banks as more risky, and therefore charge more for their money.
However, these costs would be more than offset by the benefits of "materially reducing the probability and impact of financial crises", the report said.
The report also recommended that Lloyds Banking Group should sell more of its branches in order to increase competition on the High Street.
Lloyds is already in the process of selling about 600 branches, but Mr Vickers said competition in High Street banking would benefit from further branch sales.
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However, in its interim report the commission stopped short of recommending the two should operate as separate entities.
It said more competition was needed in retail banking, including the sell-off of more Lloyds branches.
The commission's final recommendations will be published in September.
The banking commission was set up by the government last June to review UK banks after the financial crisis.
Bank shares reacted positively to the report, with Barclays and Royal Bank of Scotland rising about 3% in early trading
Cash reserves The report said that, in the build-up to the crisis, lenders and borrowers took on "excessive and ill-understood risks".
Continue reading the main story “Start Quote
Some will claim that the Commission has been too timid - in that it has rejected more radical alternatives, such as breaking up the banks”
End Quote
It added that implicit taxpayer support for the banks encourages "too much risk taking".
The commission said that banks needed to hold more cash in reserve to protect against future crises, and that creditors, not taxpayers, should be liable for any losses.
The report recommended that banks should have 10% of their capital set aside to cover potential losses, higher than the 7% set out in new European regulations.
It said it was looking at forms of "retail ring-fencing" under which retail banking would would be carried out by a separate subsidiary within a wider banking group.
'Allowed to fail'
Please turn on JavaScript. Media requires JavaScript to play.Sir John Vickers, chairman of the commission, told the BBC that "total separation [of retail and investment banking] is not necessary".
"UK retail banking can be protected by its own capital cushion. Other parts of the bank should be allowed to fail."
This would lead to additional costs to the banks, some of which would fall on the wider economy, he said.
"The cost of capital is going to go up", Sir John said, but the costs to investment banks would be greater than those to retail banks.
Without an implicit government guarantee, which banks currently enjoy, lenders would view investment banks as more risky, and therefore charge more for their money.
However, these costs would be more than offset by the benefits of "materially reducing the probability and impact of financial crises", the report said.
The report also recommended that Lloyds Banking Group should sell more of its branches in order to increase competition on the High Street.
Lloyds is already in the process of selling about 600 branches, but Mr Vickers said competition in High Street banking would benefit from further branch sales.
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