FSA: creating narrow banks could raise risk

Breaking up banks to legally separate retail from investment banking could increase risks in the system, the country's top financial watchdog said on Monday.

Adair Turner, chairman of the Financial Services Authority, said there was no "silver bullet" to tackling the so-called "too big to fail" issue with systemically important banks.

"The extreme narrow banking proposal is clearly doable in practical terms, a law could be passed which achieved this effect, but I believe would fail to address the most vital problem and could produce a financial system even more vulnerable to instability than today's" Financial Services Authority Chairman, Adair Turner said.

"Such a division would clearly not be a policy response sufficient in itself," Turner told an FSA conference.

The G20 group of leading countries agreed in September that all systemically important financial institutions should have contingency plans in place for a speedy, orderly wind up by the end of 2010.

Such plans are expected to focus on so-called living wills in a bid to lessen the need for public bailouts in future. Banks fear they will be forced to simplify their structures and face prohibitively heavy capital charges on risky activities such as trading.

G20 finance ministers take stock of their financial pledges, including how to tackle too big to fail firms, in St Andrews, Scotland, on Friday and Saturday.

Momentum for regulatory reform appears worryingly to have slowed because markets have stabilised and the subject matter of reform is complex and controversial, said Philipp Hildebrand, vice chairman of the Swiss National Bank's governing board.

The most prominent banks should not resist fundamental change but support efforts to bring this about, he added. 

"What has been missing is a bold and international political commitment to put in place a framework for orderly resolution of large cross border institutions" Philipp Hildebrand, vice

"I am not proposing to create a global resolution regime to replace national regimes" he added.

Many of Britain's banks have had to be shored up at huge cost to the taxpayer, sparking a debate on whether bank's need clear legal separation of commercial and riskier investment banking activities.

Bank of England Governor, Mervyn King, has called for such break ups but has also been rebuffed by the government.

Turner said such a "Glass Steagall" approach - named after a now defunct U.S. law - could be best pursued through heavier capital requirements on riskier banking operations.

Such heavier capital requirements are being worked out by the international Basel Committee on Banking Supervision and will make a "very major contribution to addressing the 'too big to fail' problem" Turner said.

"We need a fundamental review of the trading book capital regime and a bias to conservatism for riskier and purely proprietary activities" Turner added.