Migration is an increasingly hot-button topic in Britain, with politicians falling over themselves to show how they would manage flows of incoming workers. We can't stop migration from within the European Union. But we don't want other foreign workers eating our lunch. Curiously, when it comes to the much-vilified banks, the situation is generally the opposite. The politicians, until now, haven't dared to regulate or tax the banks to the point where the big financial institutions move their headquarters to less restrictive jurisdictions abroad, mostly outside the EU.

But, suddenly, with the publication this month of the interim report of the Independent Commission on Banking, the talk is once again of foreign institutions moving in and eating the City's financial services lunch. The commission's call for the ring-fencing of retail banking from the more dangerous "casino banking" operations of the investment banks, and its proposal that banks have minimum equity capital of 10%, has raised fears that banks from elsewhere in the EU might be able to compete.

Banks from jurisdictions with lower capital requirements could set up branches in Britain or acquire existing U.K. retail banks -- and so steal lucrative retail customers. Under European Union "internal market" rules, any business established in one member state has the right to a "passport" allowing it to operate in any other.

Technically speaking, the potential competition could come from an even wider group of countries, known, prosaically, as the European Economic Area, which includes not only the 27 nations of the EU, but also Norway and -- Heaven help us! -- Liechtenstein and Iceland. Theoretically, only Switzerland and the Vatican are barred from entry.

Even worse, although the commission claims EU rules contain provisions to constrain such behavior, sneaky British banks might move their headquarters elsewhere in the EU and run their U.K. branches from some low-tax, low-­regulation center where the capital adequacy requirement is pitched at no more than the 7% demanded by Basel III.

The commission, led by Sir John Vickers, a former chief economist at the Bank of England, doesn't deny that such regulatory arbitrage is possible. In fact, the possibility that U.K. retail banks could be undercut by EU competitors is one reason why the commission's capital adequacy proposal has been pitched as low as 10%.

The commission argues that the barriers to entry in Britain's highly concentrated retail banking market are so high that the cost of setting up a competing network would be such that a mere 3% margin between Basel III and London 2011 would be insufficient to attract foreign entrants.

The only successful foreign encroachment so far has been by Spain's Banco Santander SA, now one of Britain's top five retail banks. But Santander expanded into the U.K. by acquisition and does business through a local subsidiary subject to U.K. regulatory supervision, rather than through a branch network controlled and regulated in Spain.

There are other constraints too. All retail deposits within the EEA are covered by nationally underwritten guarantees for up to €100,000 ($143,000) per customer. After the British and Dutch governments were forced to lend Iceland about $5 billion to cover their citizens' deposits in Iceland's failed Icesave bank -- and angry Icelanders in two popular referendums refused to allow their government to repay -- any foreign bank offering large-scale retail operations in Britain is bound to come under intense political and regulatory pressure at home.

Reputational issues will make a difference in the U.K., too. True, no one ever got rich by underestimating the folly of the British consumer. But the memory of the Icesave disaster may still be sufficiently fresh to deter all but the most reckless retail customer from switching his entire life savings into a lightly regulated foreign bank -- even one that pays a slightly higher rate than its U.K. competitors.

Still, the threat is real. Sweden, Ireland and even Switzerland are likely to end up with even higher capital adequacy requirements than Britain. But Germany and France, among others, are unlikely to raise their standards much higher than the Basel minimum.

Customers might think twice about investing in some barely respectable bank from a country on the verge of economic collapse, but who would think twice before investing in Europe's strong­est economies? The fact that their banks are among the most exposed to the debt of countries on the troubled fringes of the euro zone is not widely understood. If we're still angry with our own banks for what they did to the economy, why wouldn't we let the Germans eat our bankers' lunch?

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