UK Sets Out New Law to Break Up Errant Banks

Alan Copson | Britain on View | Getty Images

British banks that fail to guard their day-to-day banking from risky investment activities will face being dismantled, finance minister George Osborne is set to say later on Monday.

Britain is in the midst of a big shake-up of its system of bank regulation in the wake of the 2008 financial crisis, when 65 billion pounds ($102 billion) of public money was needed to shore up Royal Bank of Scotland and Lloyds Banking Group.

Banks are already expected to have to 'ring-fence' activities such as standard bank accounts and payments from riskier investment banking -- something which will hit major players such as Barclays, HSBC and RBS.

But Osborne says in excerpts of a speech provided by his office that he is prepared to go further and break up banks which fail to keep to the rules -- a key demand of lawmakers who reviewed government plans late last year.

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"If a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether - full separation, not just a ring fence," Osborne says. "In the jargon, we will 'electrify the ring fence'."

Under the new rules, the Bank of England will be responsible for monitoring whether banks ensure that risks taken by their investment banking arms do not endanger their retail sides.

If the BoE identifies a breach, the final politically sensitive decision on whether a bank should be forced to sell off one of the two arms will be taken by the government.

Uncertain Leverage

Legislation will go to parliament later on Monday, and in his speech Osborne is also expected to detail new rules on limits to banks' leverage.

Under the most recent plans, leverage was to be set at 33 times banks' capital, weaker than an original proposal for a maximum of 25 times.

In December, a cross-party group of lawmakers reviewing the plans said it was "not persuaded by the government's relaxation" of the leverage rule and added that the Bank of England should set the leverage cap.

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Osborne's plans are politically controversial at a time of public anger at banks, which continue to face the repercussions from scandals related to mis-selling insurance and misreporting LIBOR interest rates.

The opposition Labor Party said it was concerned that Osborne would not revert to the original proposal, and also that breaking up banks would only be possible on a bank-by-bank basis, rather than for the entire industry.

"If ... the Chancellor is planning to stop short on both the backstop powers and legislation for the leverage ratio, then there will be a very real sense ... that despite all the rhetoric the Chancellor hasn't got the appetite for the radical banking reform we need," Labor lawmaker Chris Leslie said.

But Osborne -- who will deliver his speech at U.S. investment bank J.P. Morgan's offices in the southern English city Bournemouth -- insists his reforms strike the right balance between responding to public anger and avoiding a populist overreaction.

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"Our country has paid a higher price than any other major economy for what went so badly wrong in our banking system. The anger people feel is very real.

Let's turn that anger from a force of destruction into a force for change," he says.

"Any bunch of politicians can bash the banks ... but what good would that do our country? The jobs, the investment, the banking system we all need would go with it."