A lack of clarity in the forthcoming banking bill could allow the financial lobby to wreck the ring-fence reforms, the Bank of England Governor, Sir Mervyn King, warned yesterday.
Giving evidence to the Parliamentary Commission on Banking Standards, Sir Mervyn said the legislation risked putting the onus on regulators to outline what financial activities should be permitted within the retail bank ring-fence.
"I think it would be wrong to leave it purely to the discretion of the regulator because that would increase the pressure of lobbying of banks directly on the regulator," he said.
Sir Mervyn added that without a clear direction from Parliament, regulators would be forced to negotiate with the banks over the limits to their activities – and he suggested the official sector would inevitably come off worse.
"If judgement ends up simply as a negotiation between the regulator and the regulated bank, there's only one winner in that and I think that will be a very bad outcome" he said.
However, there was disagreement between the Bank of England's Deputy Governor, Paul Tucker, and its director of financial stability, Andrew Haldane, who were both also giving evidence, about whether non-ring-fenced banks should be permitted to lend to small and medium-sized companies.
Mr Haldane agreed with the Governor on the need for clarity in the legislation and warned MPs not to be swayed by arguments from the banking lobby.
"I think we've heard the argument far too much over the past few years and we must not be held hostage in doing the right thing by the notion that the banks will stop lending," he said.
The draft banking legislation put forward by the Chancellor would allow retail banks to continue to sell simple derivatives to customers, despite a spate of mis-selling scandals in recent years.
But Sir Mervyn suggested to the committee this was inappropriate. "It's impossible to differentiate between a complicated and simple derivative," he said.
Shareholders' reluctance to fund investment banking meant management had a growing incentive to hive off this type of business or conduct it in a less risky fashion, Sir Mervyn said.