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Item Club warns ringfencing banks will harm growth

Forecasting group says that Sir John Vickers’ likely proposals could wipe 0.3% off GDP

Bank bosses fighting proposals to force them to ringfence their high street operations from higher-risk investment banking businesses have been handed fresh ammunition today with a warning that the suggested split could wipe 0.3% off gross domestic product at a time when economic growth looks increasingly fragile.

A report by the highly regarded Item Club, the only independent economic forecasting group to use the Treasury model, says the ringfencing proposal would force up the cost of lending to large corporations by 1.5%. This would then hit the wider economy and “is likely to result in a loss of up to 0.3% of GDP”.

The ringfencing proposal – designed to ensure that the government never again has to use taxpayers’ cash to bail out the so-called “casino” operations of the major banks – is expected to be the cornerstone of the Independent Commission on Banking report, due to be published next Monday. The ICB, headed by Sir John Vickers, was set up by the government after the election last year to find ways of making the banks safer. Its interim report in April backed ringfencing together with a proposal to force the banks to increase their core tier 1 capital holdings to 10%.

The Item Club’s predictions come amid mounting pressure for the Vickers proposals to be watered down. Reports over the weekend suggested that the prime minister has told senior officials that the ICB proposals must be reviewed if they are too harsh and that “light touch” regulation should be adopted if a tougher approach might put economic growth is at risk. He is also said to be worried that HSBC and Barclays might relocate abroad rather than comply with ringfencing.

The banks have been lobbying hard to dilute the proposals or delay their adoption, arguing that stricter regulation could damage the wider economy. Last week, CBI boss John Cridland lent his support, saying it would be “barking mad” for the government to impose any changes on the banks that might impinge on their ability to provide the finance businesses need to grow. On Friday, Barclays boss Bob Diamond held talks with George Osborne to press the banks’ case, and Ana Botín, the chief executive of Santander in the UK, will see the chancellor this week.

The business secretary, Vince Cable, who has long favoured a tough clampdown on the banks and supports the ringfencing proposal, last week accused the banks of being “disingenuous in the extreme” in their attempts to derail the reform.

When the proposals for ringfencing were first outlined in April they were viewed as relatively limp, and bank shares rose. Vickers was forced to deny that his commission had not gone far enough with its suggestions for reform.

According to the Item Club, ringfencing could push up the cost of wholesale funding to the investment banking divisions. At the same time, financial markets might demand that the investment banks – implicitly stripped of their government guarantees – hold tier 1 capital of 14%. “This could result in an increase in the cost of bank lending to large UK corporates of up to 150bp”, says the report.

The big banks are also under attack from US authorities, which are attempting to recoup some of the £85bn poured into supporting Fannie Mae and Freddie Mac, the guarantors for most US mortgages and leading investors in bonds backed by sub-prime mortgages.

The US Federal Housing Finance Agency filed lawsuits against 17 banks on Friday, including HSBC, Barclays and Royal Bank of Scotland, claiming they mis-sold the sub-prime investments. The claims could run into tens of billions of pounds. © Guardian News & Media Limited 2011 | Use of this content is subject to our Terms & Conditions | More Feeds