The UK government was expected today to give complete support for proposals to force banks to “ring-fence” their retail operations from investment banking functions, media reports said - a move that commentators have said should not greatly affect wealth management.

In September this year, the Independent Commission on Banking, a group set up by the government with the task of exploring reforms that will help prevent future bank bailouts, proposed a number of measures. A total of £66 billion (around $102.5 billion) of taxpayers’ money has been put into Lloyds Banking Group and Royal Bank of Scotland (source: Reuters).

In November, Steve Smith, competition and regulatory strategy director at Lloyds Banking Group, told a conference in London that he did not expect the ring-fencing idea to have a significant impact on private banking. The ring-fencing issue should put a private bank in the position of an "agent" acting for a client in relation to an investment bank, he said. (To view that article, click here).

However, as he pointed out that the time, it is not always clear whether a bank activity can be classified as investment banking or retail banking, especially in the area of some products that have been created by the investment bank and sold to the mass market, he said.

The fence

The idea essentially relates to how retail, deposit-taking banking will be required to carry higher capital to protect against risk.

Yesterday, Business Secretary Vince Cable, a leading Liberal Democrat member of the UK’s Conservative/LibDem coalition government, reportedly gave a clear indication that the ICB proposals will be implemented.

“We're going to proceed with the separation of the banks, the casinos and the retail business lending parts of the bank," he told the BBC. He said the new legislation caused by the ICB's reforms would be completed within the lifetime of the current parliament, namely before 2015. The ICB itself has said banks should have until 2019 to fully implement the proposals. This matches the deadline of the Basel committee of global banking regulators to impose tougher capital requirements on banks.

Among other proposals that the government is expected to embrace is the idea of creating “living wills” for banks, under which any bank deemed to be in significant risk of failure must implement a process under which it can be wound up as smoothly as possible.

Some organisations, such as the Institute of Economic Affairs, a UK think tank, have criticised the ring-fencing idea, arguing that splitting investment banks from retail banking would not have prevented sagas such as the near-collapse of Northern Rock (which did not have an investment bank), the huge losses of HBOS and problems at Bradford & Bingley, a mortgage lender. Some integrated banking groups, such as Barclays, have come through the credit crisis relatively unscathed.

The ring-fencing idea stops short of complete separation of banking functions into separately funded and managed units, as used to be the case in the US, for example, as a result of the Glass-Steagall legislation that was introduced in the 1930s and scrapped in the late 1990s.

The ICB said banks should hold core capital of 10 per cent, plus a further 7 to 10 per cent of capital that could take the form of "bail-in" bonds, a term referring to debt that can take a loss or convert into equity to recapitalise a bank if it enters difficulties.

There have been fears that if bank regulations are too onerous, it may push some firms to relocate their main offices away from the UK.

The debate around the banking system has even encouraged some economists to argue that the system known as “fractional reserve banking”, under which a bank, with the support of a central bank, can expand credit beyond the actual amount of cash savings held on deposit, is part of the wider problem of a financial system prone to booms and busts.