The Bank of England is implementing a series of tough new measures regulating banks which trade in securities, in a move which will cut dramatically the chances of another Barings-style derivatives disaster.
The Bank will issue today a policy notice implementing the European Union's Capital Adequacy Directive (CAD) in the UK. The Securities and Futures Authority will issue its own directive for stockbrokers and other City trading firms next week.
Until now the Bank of England has required lenders to hold certain amounts of assets in relation to their lending. Today's initiative will force banks to hold certain ratios of assets, usually shareholders' funds, to cover securities trading for short term profit.
This will mean splitting their lending book from their trading book for regulatory purposes. City critics say the move may pose problems for London as a financial centre. It will also spur the growth of securitisation and the commercial paper market.
The directive will also have a big impact on high street banks which have investment banking arms, such as NatWest and Barclays. Others - such as Lloyds, which have minimal trading activities - will be far less affected.
The directive was published by the EU in March 1993 and will take effect from 1 January 1996. The Bank of England is the first European central bank to implement it and City sources are worried that the UK's approach may be tougher than that of France and Germany, thereby making London less attractive to international banks than the continent.
Matthew Elderfield, assistant director at the London Investment Banking Association, said: "Our members generally welcome the policy notice, since it takes on board many of their suggestions from the consultation period...
"If it turns out that the bank of England's approach has been tougher than the authorities in Germany, France and the Netherlands, then we may have to make further representations."
The trade body for high street retail banks, the British Banker's Association (BBA), is also worried whether the Continentals will be softer on capital adequacy. Another problem is how existing international rules can be coordinated with the new directive.
Tim Sweeney, the director-general of the BBA, said: "The bank's rules are still at the tough end of the spectrum and we will watch closely to see how other countries implement the CAD."
In some cases the Bank of England is proposing more stringent standards than the EU's directive. For instance, the bank's present stance on counterparty risk and large exposures is tougher than those proposed by the EU.
Other areas covered include the trading book, foreign currency risk, interest rate and equity position risk and underwriting.