British banks should ringfence their retail businesses from investment banking operations to protect savers' deposits under proposals outlined by the Independent Commission on Banking (ICB) today.
The Commission is also calling for Lloyds Banking Group to sell more of its branches to improve competition in the sector, although it has stopped short of recommending a reversal of the HBOS rescue takeover.
Today's interim report - which will be followed by final recommendations in September - suggests measures designed to reform the industry following the financial crisis and protect taxpayers against future bail-outs.
The head of the review, Sir John Vickers, said there was an 'arguable case' for splitting retail banks from investment banks. He said the proposals were a 'moderate combination of the strategies rather than maxing out on total structural separation or indeed maxing out on super-high capital requirements'.
He also said the decision to allow Lloyds to merge with HBOS had been a mistake. 'This was certainly not good for competition and it turned out to be bad for financial stability as well,' he added.
He said he supported making the new Lloyds group shed more branches than the 600 ordered by European authorities, insisting: "While that would do something for competition, it's possible to do a great deal more.'
The ICB said ring-fencing banking operations would have 'several advantages', by shielding savings deposits and addressing the 'too big to fail' issue in the event of a future crisis.
This could 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 should be increased from 7% to at least 10%.
However, it has held off from the more radical options of restructuring the industry, saying a full-blown separation would be costly and could 'lose some of the benefits of universal banking'.
Instead the sector is facing a call to set up so-called internal firewalls to draw a line between the two.
Lloyds appears to have avoided its worst-case scenario to undo the HBOS takeover, despite now having a uniquely powerful position in the sector - accounting for around 30% of all current accounts in the UK.
However, the ICB made clear it believes Lloyds should offload more than the 600 branches and parts of its mortgage business being divested under current European measures to address competition concerns.
Switching between banks should also be made easier and quicker to allow new entrants to crack the market and help improve competition, the ICB added.
Brown admits 'big mistake' over banks
Britain's ex-prime minister Gordon Brown admitted on Sunday that he made a 'big mistake' in not seeking tighter regulations on banks in the lead up to the financial crisis.
The former British leader told a conference in the US that he had not fully appreciated how 'entangled' the global financial system had become when establishing the Financial Services Authority (FSA), the country's regulatory body.
'We set up the FSA believing the problem would come from the failure of an individual institution,' Brown said. 'That was the big mistake. We didn't understand just how entangled things were. I have to accept my responsibility.'
New British finance minister George Osborne has announced plans to break up the FSA and hand more regulatory power to the country's central bank, the Bank of England.
Brown said he believed the will to tighten regulation was weakening in the face of lobbying by the financial sector. 'I do believe we're going back to a race to the bottom,' he warned.
'There should be an international agreement, otherwise you'll just have banks threatening to move from one country to another,' continued Brown.
'Britain was under relentless pressure from the City (Britain's financial centre) that we were over-regulating. All through the 10 to 15 years, the battle was not that we regulated too little, but that we regulated too much,' he added.
