Bank break-up law by 2015

What did Vince Cable mean when he said this morning that the government would implement the recommendations of the Independent Commission on Banking or Vickers Commission in full?

Well, there were three central proposals - and from what I can gather, the business secretary and chancellor will tomorrow announce that they are doing two and three-quarters of them.

Which, if we're in christmassy mood and are happy to round up, means they're doing the lot, I suppose.

There is, in fact, an argument that the government is pushing ahead a bit faster than would be strictly necessary on Vickers' timetable for putting a protective ring-fence around the retail banking bits of giant universal banks like Barclays and Royal Bank of Scotland.

George Osborne will announce tomorrow that the necessary legislation will go through in the lifetime of this parliament, so by 2015 - ahead of Vickers deadline of early 2019 for these so-called prudential reforms.

And to remind you, this will be a significant change, and a potentially expensive one for big banks.

When enacted, the banks will have to put their European retail banking assets, liabilities and services into legally separate subsidiaries.

These subsidiaries will have their own discreet pools of capital to absorb losses; they will report what's going on to the world at large as though they were wholly independent businesses; and they will have their own boards.

In practice the ring-fence should mean that banking for individuals and small businesses will be insulated from the risks of investment banking, without full physical separation.

Savings come first

The second important thing that's happening is that insured retail deposits - or your and my savings that are protected from loss by the Financial Services Compensation Scheme - will for the first time rank ahead of unsecured loans to banks in the extreme case of a bank going bust.

This matters, because in theory it will give a more potent incentive to the money managers who lend to banks to prevent those banks taking stupid risks.

If unsecured lenders to a bank know that in any wind-up of said bank first losses go to retail depositors, and not to them, those lenders will feel confident that little or any of the losses will ever fall on them.

In those circumstances, they don't need to bother to stop a bank like Royal Bank of Scotland going on a reckless lending or investing spree: as happened in the appalling case of RBS in 2008-9, taxpayers will always bail out the bank, at no matter what cost, to protect depositors - which in practice means unsecured lenders are rescued too.

Here is the thing: if those lenders could have had RBS's losses foisted on them, prior to any liability for depositors, they might have tried to stop some of RBS's loonier behaviour.

Or to put it another way, legislating for what is called "depositor preference" should reduce the potential exposure of taxpayers in any future banking crisis.

That said, if unsecured lenders to banks feel more exposed to risk, they will charge more for loans. Which is why banks aren't thrilled by the reform, because they fear it could squeeze their profits or force them to push up what they charge for loans to individuals and businesses.

That said, the big banks - especially HSBC - have succeeded in persuading the Treasury to water down one of Vickers' important recommendations. This is the quarter of the three central reforms that won't be implemented.

I am going to get a bit technical here, so bear with me.

Vickers proposed that the biggest UK global banks should have the ability to absorb losses equivalent to between 17% and 20% of worldwide risk-weighted assets.

Broadly this means big banks should have enough capital plus loans that can be "bailed in" and turned into equity capital to cope with losses equivalent to around a fifth of the size of their respective balance sheets (adjusted for risk).

In practice this should mean lenders could incur much bigger losses before there would be any pain for taxpayers. So you probably think it's a good idea.

Now as I understand it, HSBC argued this reform would be hugely, disproportionately expensive for it, for two reasons: HSBC is massively bigger outside the UK than inside; and compared with other British banks, it currently has relatively low reliance on unsecured borrowing from money managers and other "wholesale" providers.

So for HSBC to have loss-absorbing capacity equivalent to 17% to 20% of its total balance sheet would require it to raise a colossal amount of expensive new capital or pricey loans that would convert into capital in some circumstances.

My sense therefore is that the Treasury has in some way softened what Vickers proposed - perhaps by making the 17% to 20% rule apply only to a big international banks' UK balance sheet, not its full balance sheet.

Whether this represents a major victory by big banks over ministers who are worried that an HSBC could otherwise relocate its head office abroad to escape the reforms, we'll see tomorrow.

But overall it looks to me that Sir John Vickers and his fellow commissioners have got broadly what they wanted - and our banks will in the coming five years be forced to undergo significant financial, cultural and managerial reconstruction.