Government to water down bank reform plans

Chancellor refuses to order full separation of retail and investment operations

George Osborne is set to water down a key requirement of the Vickers Commission on banking reform, which called for lenders' high street banking arms to be "ring-fenced" from their casino investment operations.

In a White Paper on Thursday, which will commit the Government to introducing such a ring-fence, the Treasury will also outline plans to allow retail operations to continue to sell derivatives to small businesses.

Derivatives are financial instruments designed to allow companies to "hedge" against unexpected fluctuations in interest rates or exchange rates which could hit their revenues. The move is likely to be controversial because the Vickers Commission recommended last September that all ring-fenced banks should be prohibited from selling potentially risky financial products such as derivatives to customers.

The exemption will be doubly contentious because hundreds of small businesses have accused high-street banks of mis-selling complex derivatives in recent years. London & Westcountry Estates, an operator of 28 business parks in Devon and Cornwall, claims it collapsed in March this year because of an interest-rate derivative it was sold by the Royal Bank of Scotland in 2008. The Financial Services Authority is conducting an investigation.

However, British banks have lobbied for the sale of derivatives to be permitted to continue inside the ring-fence. And the Treasury is understood to have been persuaded the sale of derivatives provides a basic hedging service to customers, rather than a means for banks to engage in financial speculation.

Yet the concession will stoke concerns that the Chancellor has been unduly influenced by the financial services lobby over the implementation of Vickers. The Independent revealed last December that bank executives had been in contact with senior Treasury ministers nine times in the fortnight after the Vickers report was published.

Sir John Vickers himself, who chaired the Independent Commission on Banking, has warned ministers not to give in to financial-sector lobbying. He told a joint committee of both houses of Parliament in October: "One sees evidence of lobbying activity in a variety of jurisdictions on these fronts and I think it's very important there is strong resistance. It is for Government and Parliament to resist emasculation or watering down."

The Vickers ring-fence will require the UK's largest banks to hold more capital against their deposit-taking retail banking operations and also to make it simple for these arms to be separated off from the parent organisation in the event of a crisis. The objective is to prevent banks using the savings of ordinary customers to make risky bets in the global capital markets.

The report also recommended that all banks be required to hold a significantly larger capital buffer to decrease the likelihood of them requiring a bailout by taxpayers.

However, the report also said the banks should have until 2019 to introduce these reforms and raise more capital. Robert Jenkins, a member of the UK's new financial regulator, the Financial Policy Committee, has warned that this timetable is too relaxed and "will allow lobbyists to chip away until the proposal becomes both unrecognisable and ineffective".