Britain's biggest banks are bracing themselves for a government-commissioned report tomorrow that will recommend a fundamental overhaul of the way they do business.
The interim report by the Independent Banking Commission (IBC) is expected to propose that banks separate their traditional functions, such as savings accounts, from riskier investment banking divisions. It is also expected to say that the merger of Lloyds TSB and HBOS at the peak of the financial crisis was an error, and that Gordon Brown should not have waived competition law to enable the merger to take place.
The IBC, chaired by the former Bank of England chief economist Sir John Vickers, was charged with finding ways of bringing greater stability to the banking system. The coalition wants to ensure that the taxpayer never again has to bail out banks should the financial bets of their investment teams cause massive losses.
The proposals will stop short of splitting up the banks. Instead, these "universal banks" will in effect have distinct subsidiaries, so that high street deposits could not be used to underwrite investment banking gambles in the capital markets.
However, there were warnings yesterday that this could vastly increase the cost of borrowing and take years to implement due to technology difficulties. David Sayer, global head of retail banking at the accountant KPMG, said: "If the use of customer deposits is restricted, the cost of loans could go up." If high street deposits can no longer be used to support lucrative investment banking deals, then there is little incentive to keep loans cheap.
There is also confusion as to whether lending to corporates will be considered part of the retail or investment banking divisions. If business loans join investment banking, their cost could go up.
Unravelling the functions will take time. Ben Wilson, head of financial services at the technology industry trade body Intellect, warned: "It is a fair assumption that this could take up to three years. There are legacy systems built on legacy systems, layer upon layer [of data] over a couple of decades." He added that cash machines have failed for hours at a time after merger deals because IT systems failed to mesh.
The big banks, such as Barclays and HSBC, have been lobbying against strict ring-fencing between retail and investment banking divisions because of costs estimated at up to £15bn a year. Critics also point out that the big bank collapses during the crash would not have been prevented by separating business functions.
However, it is understood that over the past few weeks there have been more useful discussions between the IBC and the banking chiefs. Treasury sources said that George Osborne welcomed the structural reforms but would not give his backing to specific recommendations until the report had been fully debated by Parliament.
The Treasury Select Committee is expected to be broadly supportive, with one member saying that having separate banking divisions under a main holding company "ticks all the boxes". The committee chairman, Andrew Tyrie, added: "This is the most important set of reforms to the banking industry for generations and will, hopefully, create safer banks. But it is also essential that the proposals push for more competition."
The number of UK banks has halved in the past decade, meaning that depositors have been unable to shop around for better credit terms. In his blog yesterday, the Shadow Chancellor, Ed Balls, wrote: "We need tough action to promote greater competition too, including making it easier for customers to move their main bank account."
However, he warned that banking reform required international agreement, so that banks did not move operations to countries with lighter regulations. "If George Osborne fails to secure international consensus and we see those jobs move abroad, he will be letting Britain down."
The commission's final report is due in the autumn.