The white paper, which remains subject to a near-three-month consultation, marks an ambitious attempt by the state to prevent multibillion-pound banking bailouts while avoiding reforms that would choke Britain's already stuttering economic growth or prompt U.K. lenders to take the next flight overseas.
Though leaving many unanswered questions, the 86-page report showed officials had heeded banks' furious lobbying in key areas.
The centerpiece of the reforms is the enforced split of retail banking from investment banking. Retail banking would be grouped into a "ringfenced" entity that must carry a mandatory buffer of 10% of Tier 1 capital. The ringfenced operations must be economically and legally separate from the rest of its group, run by an independent board, and refrain from most international wholesale and investment banking activities.
The government plans to give some discretion to lenders about which operations can sit in the ringfenced unit, while warning that secondary legislation may be necessary to define what must only be undertaken within the ringfence.
It also confirmed it would allow ringfenced banks to offer "simple hedging products" in order to cater to the needs of small and medium-sized enterprises.
"The white paper acknowledges that a ringfence covering purely retail banking would be too narrow. It recognizes a difference between investment banking and 'more traditional personal and business lending,' " noted PricewaterhouseCoopers LLP U.K. retail banking leader Steve Davies. "This together with the acknowledgement of the need for limited hedging activities are perhaps some of the most significant changes from the original proposals, although they come with a requirement for additional risk management safeguards for the ringfenced entity."
In a major victory for global behemoth HSBC Holdings plc, Europe's largest bank by market value, the government also jettisoned a proposal for U.K. banks to hold extra capital against their overseas operations, provided they can show these pose no risk to their domestic businesses.
"The Government believes that a primary loss absorbing capacity of 17% of risk-weighted assets is broadly the appropriate level for U.K. banks. Their overseas operations will be exempt if they are resolvable without risk to U.K. taxpayers, but additional loss absorbing capacity may be required of firms if resolvability concerns persist," Chancellor of the Exchequer George Osborne and Business Secretary Vince Cable wrote in the report.
The government also dismissed the ICB's call to raise the binding leverage ratio beyond the 3% stipulated under Basel III. The ICB had wanted a 4.06% ratio, and ICB Chairman John Vickers, a former chief economist at the Bank of England, issued a statement Thursday urging the government "to resist pressure to weaken" the effectiveness of the commission's proposals.
In a move that could prompt challenges, the government also plans to enshrine the principle of "depositor preference" in the event a bank collapses. It wants holders of the first £85,000 ($132,056) of deposits held within any one bank that are covered by a government guarantee scheme to stand first in line among creditors.
The move "should sharpen the incentives for other senior unsecured creditors to exert discipline on banks' behavior," the report said.
The government also said it will amend the 2000 Financial Services and Markets Act to allow certain regulatory costs met by the Treasury to be recouped from the banking industry. The change would cover the cost of funding the Financial Stability Board, which is funded by the Bank for International Settlements, but may in the future ask members to contribute.
The government-commissioned ICB's remit also included examining ways to make the banking sector more competitive, and proposals from the Financial Services Authority and Bank of England about how to lower barriers to new entrants are due out in the fall.
The white paper is the precursor to the second major piece of financial services legislation the government will introduce to Parliament this year. The separate Financial Services Bill is due to become law early next year. That legislation will replace the Financial Services Authority with three regulators: a "macro" supervisor, the Financial Policy Committee; the Prudential Regulatory Authority, which will monitor individual institutions; and the Financial Conduct Authority, charged with consumer protection. Both the FPC and the PRA will sit within the Bank of England.
The government said it wants primary and secondary legislation to establish the reforms outlined in Thursday's white paper to be in place by May 2015, with banks having until 2019 to implement the proposals.
Osborne will Thursday night sell the reforms to the City's elite during the chancellor's annual Mansion House speech.
The consultation closes Sept. 6. Shares in the U.K.'s leading banks closed up, with Royal Bank of Scotland Group plc and Barclays plc leading the gains, rising 3.1% and 2.4%, respectively.
Todd P. Kelly joined the Dallas Office of Jones Day as a partner in the healthcare and life sciences practice. For other updates launch today's Movers & shakers slideshow.
The Jordan Co. managing director talks about manufacturing M&A with private equity senior editor Jonathan Marino. More video