David Prosser: Ring-fencing the banks may work in ways the Chancellor never intended

Outlook If George Osborne feels in need of support from bankers for his plan to make them ring-fence their retail assets, he need look no further than the most recent meeting of the Treasury Select Committee, where one prominent banking executive told MPs he was very much in favour of the policy.

Still, Antonio Horta-Osorio – for it was he – is not exactly a dispassionate observer. Lloyds Banking Group, where he is chief executive, is the only one of the big four banks not to have substantial investment banking operations – and thus need not trouble itself too much with the intricacies of ring-fencing.

Quite the reverse, in fact. The Chancellor's proposals appear to hand Lloyds an advantage. While the retail bank operations of its main rivals are about to be fettered by a raft of new regulation, Lloyds will be largely unaffected.

That's ironic for two reasons. First, HBOS, the bank which merged with Lloyds at the height of the credit crunch, came closer than any other large British bank to collapse during the crisis. Second, the Independent Commission on Banking, whose proposals Mr Osborne is adopting, has a remit to encourage competition as well as to promote financial stability. Giving the UK's dominant player in current accounts and mortgages an extra competitive advantage looks rather odd in that context.

None of which is to say that the Chancellor is wrong to back the idea of ring-fencing – just that, as usual, the law of unintended consequences will apply.

There will be other examples, too. One positive competitive effect of ring-fencing, for instance, might be to make it easier for new entrants to break into the market. The bar to launching a retail bank from scratch is very high, not least because the free banking model requires new entrants to absorb sizeable losses for a prolonged period. Were ring-fencing to result in a move away from free banking, however, new current account providers might not have to wait so long to break even.

And how will these proposals affect the sort of risk-taking that lay at the heart of the financial crisis? It may be that retail banks, safe in the knowledge that they retain their government guarantee, are tempted to take more risks than in the past, while investment banks, now stripped of that safety net, may become cautious. That would be another curiosity.

It is not possible to answer these questions yet, since we do not have much in the way of detail about what the Chancellor proposed last night. But one thing is already clear: while adopting the banking commission's proposal on ring-fencing is the most straightforward course of action open to Mr Osborne, the effects of doing so will be anything but.