ANALYSIS:Threatened exodus off the cards as reform proposals steer clear of sweeping changes, writes MEGAN MURPHYand SHARLENE GOFF

AS RECENTLY as six months ago, a report calling for leading UK banks to construct expensive and ill-defined “firewalls” around their sprawling retail businesses would likely have prompted a big sell-off by investors.

So why did shares of Barclays and Royal Bank of Scotland rise yesterday following the release of the UK 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, Britain’s banks have been waging a fierce lobbying campaign against the imposition of far more draconian measures, such as a wholesale break-up of universal banks or forcing them to separately capitalise their investment banking arms.

Amid fears the commission would propose more sweeping changes than US, Asian or continental European regulators, senior bankers such as Bob Diamond, Barclays chief executive, and Douglas Flinch, HSBC chairman, stepped up their threats of a banking exodus from the UK.

On Monday the five-member commission, chaired by Sir John Vickers, ruled out the most extreme options in their interim report on the reform options available.

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 – comprised of top-quality equity capital – of at least 10 per cent, three percentage points higher than the minimum required by international regulators under the Basel III framework.

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

It is higher, however, than other countries’ current targets, and could push up banks’ funding costs – and in turn the costs borne by consumers – if banks feel they have to hold more than the minimum capital cushion, say 12 per cent or 13 per cent.

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

That proposal is designed to address the biggest conundrum facing governments and bank regulators across the world – how can big banks be allowed to fail without putting taxpayers’ money at risk, as happened in the last financial crisis? –