New rules to cost banks up to 7 billion pound a year

A flag flies over the former headquarters and registered office of the Royal Bank of Scotland (RBS) in Edinburgh, Scotland March 29, 2012.

LONDON (Reuters) - A reform of Britain's banks aimed at protecting consumers and preventing a repeat of the reckless risk-taking that led to huge taxpayer bailouts in 2008 will cost the industry up to 7 billion pound a year, the government said on Thursday.

Britain, which used to pride itself on its light-touch regulation, was one of the countries hardest hit by the 2008 financial crisis due to the size of its banking industry.

It shelled out over 60 billion pounds of taxpayer cash to rescue RBS and Lloyds, two of its biggest lenders, and is still struggling to emerge from recession.

In a "White Paper," which will be followed by draft legislation in the autumn, the government set out its latest thinking on reforming the industry, including a requirement for banks to ringfence their domestic retail operations and give savers a higher priority in the event lenders hit trouble.

It is also pressing ahead with plans for British banks to have larger capital buffers than in any country except Switzerland, in a move which critics fear could hit lending and damage economic recovery.

"The proposals for additional capital requirements are above and beyond those already agreed internationally, which will make it harder for banks to lend to businesses," the Confederation of British Industry said in a statement.

However, the government watered down its proposed lending rules for banks to bring them into line with international standards, which analysts said showed an anxiety not to put the industry at a competitive disadvantage and to promote growth.

"There must be a political agenda now to actually ensure that there is growth and a reasonable supply of credit into the economy and I think to have over-egged it would have been quite damaging," said Oriel Securities analyst Mike Trippitt.

John Vickers, the Oxford University academic who led a 15-month review of the banking industry that formed the basis for the reforms, was critical of this softer stance.

"The White Paper proposals are far-reaching, but on some points - such as limits on the leverage of big banks - we believe they should go further," he said.

Vickers' Independent Commission on Banking proposed banks should have a leverage ratio - which measures pure equity capital to gross loans and investments - of up to 4.06 percent, but the white paper said it only needed to be 3 percent.

Treasury minister Mark Hoban defended the reforms.

"We will ensure that British banks will be resilient, stable and competitive and so attractive to investors at home and abroad," he told parliament. "The euro zone crisis makes reform more, not less, important."

HEFTY COST

In line with its earlier thinking, the government said banks would need to hold a buffer, or primary loss-absorbing capital, equivalent to at least 17 percent of risk-weighted assets, much higher than international standards.

New global regulations due to come into force in 2019 ask banks to hold a minimum of 7 percent capital, or 9.5 percent for the biggest institutions.

Banks will not have to hold such high capital levels for their international assets, which HSBC had said could have cost it an extra $2.1 billion a year.

The government also confirmed retail depositors would be ranked ahead of all other creditors, and bondholders would be behind them in the queue should a bank become insolvent.

It estimates the annual cost of the reforms will be 4-7 billion pounds for the banks, having previously put the impact at 3.5-8.0 billion. It will cost another 2.5 billion pounds in one-off transitional costs.

The government expects its banks, which will have to pay more to borrow money, will require an additional 19 billion pounds of equity to comply with the reforms.

That new equity will reduce the value of the state's 82 percent stake in Royal Bank of Scotland (RBS) and 40 percent stake in Lloyds by a total of 6-9 billion pounds, it said.

The reforms could lead to an increase in gross domestic product of 9.5 billion pounds each year, it estimated.

The government said the Bank of England and Financial Services Authority are conducting reviews to ensure current regulations "do not pose excessive barriers to entry for prospective new entrants". Critics have said it is too difficult for new banks to emerge to challenge the established operators.

Attempts by Lloyds to sell 632 branches to comply with European Union state aid rules have been undermined by the regulatory obstacles faced by would-be buyers.

The government wants to pass formal legislation on banking reform by the end of this Parliament in May 2015 and banks would need to comply with the measures by 2019.

Shares in RBS closed up 3.1 percent at 229.4 pence with Barclays up 2.4 percent at 192.75 pence, Lloyds up 0.4 percent to 29.75 pence and HSBC up 0.1 percent to 545.5 pence.

(Additional reporting by Steve Slater, Sven Egenter and Fiona Fairbairn; Editing by Elaine Hardcastle and Mark Potter)