* Bank standards commission will endorse ring-fence plan * To recommend break-up threat if banks don't comply * Simple derivatives can sit within ring-fence * Commission unhappy about lack of detail in bill By Matt Scuffham LONDON, Dec 18 (Reuters) - Britain will get the go-ahead toforce banks to shield their routine retail operations fromriskier investment banking activities when lawmakers announcethe conclusions of an inquiry into banking reform on Friday. The Parliamentary Commission on Banking Standards will alsorecommend that the government can resort to a "nuclear option"of breaking up banks if they try to find ways around the newrules, commission sources said. Britain is reforming its banks to avoid a repeat of thefailures of 2008 when it was forced to pump 45 billion pounds($73 billion) and 20 billion pounds into Royal Bank of Scotland and Lloyds Banking Group respectively to keepthem afloat at the height of the global financial crisis. The commission, initially set up to examine the conduct of banks following a series of scandals, was asked by FinanceMinister George Osborne in October to conduct pre-legislativescrutiny of the government's Banking Reform Bill. Commission members have expressed concerns over the lack ofdetail in the bill which they believe makes legislationvulnerable to being watered down if bank lobbyists put pressureon future governments. The commission has considered ways to avoid that and willrecommend the threat of full separation if banks don't comply -an idea supported by several witnesses, including John Vickers,who was the architect of the initial proposals as head of theIndependent Commission on Banking. "There is concern over the circumventing or undermining ofthe ring-fence by banks and that, over time, there will be anerosion of the effectiveness of it," one of the commissionsources said. Vickers' plans are designed to protect the taxpayer byputting a shield around deposits from individuals and smallbusinesses so that they are not at risk in a bank failure andthe government is therefore not required to step in to rescue anailing institution. However, some committee members, including former BritishFinance Minister Nigel Lawson, have argued that full separationoffers a better remedy and would stop the more aggressiveculture of investment banks infiltrating retail banks. They believe that culture is partly to blame for themisselling of payment protection insurance by retail banks,which has cost the industry billions of pounds in compensation,and the misselling of unsuitable interest rate swaps to smallbusinesses. The cross-party commission, which is headed by ConservativeAndrew Tyrie and also includes the next Archbishop ofCanterbury, Justin Welby, has spent the last three monthsdeliberating over reform of the industry. It has taken evidence from the chief executives of allBritain's major banks as well as regulators, politicians andcentral bankers. Influential voices from overseas also contributed to thedebate. Paul Volcker, the former Federal Reserve Chairman at theforefront of regulatory thinking in the United States appearedas did Erkki Liikanen, the governor of the Bank of Finland, whohas said European banks should separate deposit-takingbusinesses. Banks reluctantly accepted the principle of ring-fencingafter initial resistance although some remain unconvinced. RBSChief Executive Stephen Hester told the commission the proposalscarried a "huge risk of moral hazard". "You are giving a charter in everyone's minds for the nexttime there is a problem inside the ring fence, (the bank) getsbailed out by one mechanism or another," he said. Hester argued that the majority of the industry's problemshad occurred within retail banking, rather than investmentbanking, and said authorities should aim for a system in whichno part of a bank needs bailing out. The commission has debated at length whether banks should beallowed to sell derivatives within the ring-fenced operations.Interest rate swaps are at the centre of a misselling scandalwhich could cost banks billions of pounds. Britain's financialregulator estimates 44,000 interest rate swaps have been wronglysold to small businesses. A commission source said it was likely to recommend simplederivatives will be allowed within the ring-fence if they arerelevant to the businesses acquiring them. The commission will intensify its examination of bankingstandards in the new year.
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