City lawyers have reacted critically to the Vickers report's proposals for reform of the UK banking sector, highlighting the potentially damaging impact on the City's status as a global banking hub.

Key proposals contained within the interim report from the Independent Commission on Banking (ICB) include the suggestion that UK banks should ring-fence their retail divisions from their investment banking arms and that there should be increased capital requirements for "systemically important banks".

The report also concludes that a higher level of competition is required in retail banking, and in particular urges Lloyds to sell off further branches.

The review, led by Sir John Vickers (pictured), a former Bank of England chief economist and head of the Office of Fair Trading, was set out in June 2010 by Chancellor George Osborne.

The report's proposals are designed to reduce risk in the banking sector, mitigate moral hazards, decrease the likelihood of future bank failures and promote competition in retail and investment banking.

However, many City lawyers are concerned that the proposals will have a negative impact on London's strength as a business hub.

Nabarro corporate partner Alasdair Steele said: "The ICB acknowledges that implementing its reforms will cost the banks. Shareholders and investors are unlikely to bear the full brunt of these changes so, if they are followed through, we can all expect to pay more for our banking through higher costs and fees and lower returns on our savings.

"The ICB acknowledges that there is a lack of empirical data on whether the proposed reforms will drive major banks away from the UK. It seems to dismiss the future risk to the City of any such relocation, but while the immediate impact of the loss of a major bank's headquarters may be relatively small, the long term risk is considerably greater. New products and business lines are more likely to be developed from headquarters outside the UK, which over time will lessen the importance and influence of London as a financial centre."

Ashurst regulatory partner Rob Moulton said: "The Banking Commission has tried to chart a course between splitting up the banks, and not disrupting their role. This is a difficult course to plot. Banks are either separate or they are integrated in some way. Like pregnancy and death, you either are or you aren't.

"The balanced route gives rise to lots of unanswered questions. How will the failure of the investment banking arm of a retail bank not impact upon the credibility of its retail operations, which depend upon continued public confidence? Will the proposal encourage banks to operate their main businesses from abroad, where no such restrictions apply, and conduct their UK operations from a branch in London?"

The final findings of the ICB will be published in September, although the Government is not obliged to comply with the commission's conclusions.

Market reaction to the proposals

"The decision not to go the whole way to require the splitting up the banks is welcome, but this halfway house will only succeed if it is workable and does not leave the UK at a competitive disadvantage globally. The jury is still out on this."
Jonathan Herbst, financial services regulation partner, Norton Rose

"Banks are, and will remain, highly leveraged businesses. The Commission's proposals go some way towards eliminating incentives for management of banks to assume dangerous levels of risk. They also represent a recognition that there are limits to the ability of the UK to act unilaterally.

"The Commission clearly recognises that enhanced equity requirements, although useful in reducing the risk of future taxpayer funded bailouts, won't by themselves be sufficient. Remedying the perceived failure of bank creditors to pull their weight in the past is high on their agenda. Although the systemic risk inherent in the imposition of bail-ins on existing bank creditors makes that approach unlikely, the Commission's Interim Report represents a further step down the road towards loss sharing for future lenders to banks."
Tom Budd, co-partner-in-charge and co-chair of the global finance group, Gibson Dunn & Crutcher

"The public interest cuts both ways. It is as important for the UK to have a vibrant banking industry as it is to protect the public against the consequences of systemic failure. We have seen regulatory 'goldplating' in other parts of the financial services sector which has neither protected against the relocation of businesses to more competitive jurisdictions nor wholly protected against the possibility of failure. The focus should be more on how to deal with orderly resolution if things go wrong, than on expensive capital requirements and potentially burdensome structural changes, neither of which will wholly achieve their stated objectives."
James Bateson, head of financial institutions, Norton Rose