As recently as six months ago, a report calling for leading UK banks to construct expensive and ill-defined firewalls around their retail businesses would probably have prompted a big sell-off by investors.

So why did shares of Barclays and Royal Bank of Scotland rise on Monday after the release of the Independent Commission on Banking’s proposals for safeguarding the sector, which recommended exactly that? Simply put, it is not nearly as bad as it could have been.

For months, the big banks have been waging a fierce lobbying campaign against the imposition of far more draconian measures, such as a Glass-Steagall-style break-up or forcing them to separately capitalise their sprawling investment banking arms.

Amid fears that the commission would propose sweeping changes that would handicap the sector, senior bankers such as Bob Diamond, Barclays chief executive, and Douglas Flint, HSBC chairman, stepped up threats of an exodus from the UK.

To their relief, the five-member commission, chaired by Sir John Vickers, on Monday ruled out the most extreme options in its 200-page interim report on the reform choices available.

But that does not mean Sir John’s proposals are not far-reaching, or will not, if adopted, reshape an industry whose total balance sheet is still more than four times the UK’s annual gross domestic product. At the heart of the panel’s work to date is the recommendation that large UK retail operations hold a so-called core tier one capital ratio – top-quality equity capital – of at least 10 per cent, three percentage points higher than the minimum required by international regulators under the current Basel III framework.

That is in line with what most big UK banking groups already have, and is what ratio regulators are expected to demand from so-called “systemically important” financial institutions when those rules are finalised later this year.

It is higher, however, than the level that some other countries, such as the US, are targeting, and could significantly push up UK banks’ costs – and in turn the costs borne by consumers – if banks decide they have to hold more than the minimum capital cushion, say 12 or 13 per cent.

The other main idea put forward is ring-fencing UK retail operations, ensuring that depositors’ money and essential payment services still function in the event that a big universal bank comes close to collapse.

That proposal is designed to address the biggest conundrum facing governments and bank regulators: how can big banks be allowed to fail without taxpayers having to bail them out, as happened in the last financial crisis?

At first blush, ring-fencing UK retail activities appeared to be a neat step towards solving that problem, and less costly than requiring banks to put their riskier investment banking operations in separately capitalised subsidiaries, analysts said.

But as with most proposals, the devil will be in the final detail. Sir John declined to elaborate on Monday on precisely how a retail ring-fence would work, or which portions of a bank’s business would be set behind a firewall.

At big UK banks, “retail banking” typically encompasses far more than current accounts and mortgages. Determining where the lines will be drawn around activities such as small business lending, credit card operations or hedging transactions for corporate customers will make a big difference as to how much the commission’s proposals would cost the big universal banks.

But it is a less radical recommendation than some of the industry’s biggest critics were demanding, and led to accusations that the commission had been too timid. Sir John staunchly dismissed suggestions that its proposals did not go far enough to protect the taxpayer against future banking failures.

“I absolutely reject the notion that we bottled it,” he said at Monday’s launch. “There is no sense that these are half measures. They enormously reduce the chances of calling on the taxpayer for support.”

Sir John acknowledged that the commission considered more radical options – including hitting banks with a “sky high” capital ratio of up to 20 per cent – before deciding go with the “more moderate” combination of ring-fencing and a
10 per cent capital cushion. However, he also acknowledged there could be no certainty that the measures outlined would prevent a future financial crisis.

Bankers may be breathing sighs of relief for now – “we dodged a bullet” was the main refrain – but there is some heated debate to come before the commission releases its final recommendations in September. “The market has reacted as if it’s not nearly as bad as it could have been, but that’s just the market,” said one.

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