UK bank giants should protect their retail arms from risky investment banking and put more capital aside to prevent future taxpayer bail-outs, according to a key report today.
The Government-appointed Independent Commission on Banking (ICB) has called for retail business to be ring-fenced from so-called "casino" banking to protect savers and borrowers in the event of a future crisis.
Lloyds Banking Group should also go further to address competition concerns and sell off more than the 600 branches it has currently agreed with Europe, the ICB said.
Its interim report, which will be followed by final recommendations in September, has proposed a raft of reforms to increase stability and promote competition - including making it easier to switch banks.
But the report stopped short of many of the more drastic measures on the table, such as a full-blown separation of retail and investment banking and a reversal of the HBOS rescue takeover by Lloyds.
The reaction in the market suggested the bank sector had escaped the worst, with shares in Barclays and part-nationalised Royal Bank of Scotland 3% and 2% higher respectively as investors breathed a sigh of relief.
Lloyds shares held firm in a sign the group has emerged relatively unscathed, despite facing a new round of branch and business disposals.
But there were concerns over the eventual cost to consumers of many of the ICB's proposals, while the commission also faced accusations of having let banks off the hook.
Bank analyst Bruce Packard, at Seymour Pierce stockbrokers, said he expects banks to be "secretly pleased" at the proposals.
Trade union Unite voiced fears that the ICB was simply tinkering at the edges, but would create major uncertainty for embattled Lloyds workers as yet more branches look set to go on the sale block.
Sir John Vickers, chairman of the five-strong panel leading the year-long banking probe, stressed the commission had opted for a combination of a range of measures rather than the most drastic changes, which together would "make the world of difference to UK retail banking".
"In no sense at all are these half measures," he said.
"These are far-reaching reforms - if reforms of this kind were implemented, this could be transformative."
The ICB report suggests retail operations should be separated from investment bank business by internal firewalls, which would mean savings deposits were protected while also addressing the "too big to fail" issue in the event of a future crisis.
This should be combined with tougher requirements for banks to hold more capital aside as a cushion to limit taxpayer exposure.
The watchdog believes that current international capital ratio rules do not go far enough and that large banks should maintain a minimum equity capital base of at least 10%, which is 3% above current requirements.
The UK should adopt these rules even if it cannot be agreed at an international level to help ensure British taxpayers do not have to bail out banks again, said the ICB.
The ICB said a full-blown separation of retail and investment banking would be costly and could "lose some of the benefits of universal banking".
It added that, while the hurried-through takeover of HBOS by Lloyds was a mistake in competition terms, it would not be sensible to reverse.
However, the ICB made clear it believes Lloyds should offload more than the 600 branches and parts of its mortgage and savings business being divested under current European measures to address competition concerns.
Lloyds is by far the biggest retail bank in the UK, with around 30% of the current account market and 21% of the savings market.
However, the ICB said even after the current EU divestments Lloyds would still account for 18% of savings business and 25% of current accounts - remaining a clear market leader.
Lloyds hit out at the ICB's proposals to force it to sell off more branches, claiming the move "would not be in the interest of our customers" and could significantly delay its efforts to meet the commitments agreed between the Government and EU.
Antonio Horta-Osorio, who took over as chief executive of Lloyds this year, said: "This option appears to be based on limited evidence and may paradoxically potentially delay a new competitor coming into the UK market."
Its recommendations to make switching easier and quicker to allow new entrants to crack the market were cheered by a raft of consumer groups and smaller banking players.
Mike O'Connor, chief executive of Consumer Focus, said: "We welcome moves to encourage switching of accounts, which our research shows is unnecessarily problematic.
"Greater switching levels would be a sign that competition is working but before that happens we must end unfair charges and allow greater comparability between accounts."
Experts raised concerns that the greater capital requirements would push up mortgage, loan and other credit costs for consumers, while also making it harder for more entrants to join the market.
The Commission conceded that costs were likely to rise for banks, but said mostly this would be within the investment banking division rather than retail operations.
Some of these costs would inevitably be passed on to customers, as well as bank investors and in reducing bank pay, but the trade-off would be in significantly limited taxpayer exposure to bail-outs, Sir John said.
"Safeguards for retail banking, on which so many rely in everyday life, is common sense," he added.Reuse content