The move last week by the European Commission to break up the Royal Bank of Scotland and Lloyds TSB, the bloated beneficiaries of state aid, may be a clue as to the future and unexpected direction of the banking sector.

In the past two years the sector in Europe and America has moved from an idyll of market-driven, light-touch regulation to a regime of control and diktat by bureaucrats and regulators.

How is it going to shape up in the medium to long term? The commission’s intervention was not in itself unexpected and talk of RBS and Lloyds being “penalised” (as some commentators described it) may be slightly wide of the mark.

Michael Grenfell, of Norton Rose, says: “The UK had to get the approval of the European Commission to make rescue aid available to the banks last autumn. This normally lasts for six months. However, because of the scale of the crisis Neelie Kroes, the European Commissioner for Competition, took a pragmatic view and permitted it to be extended to 12 months.”

The catch was that if the aid continued for longer than 12 months (as is the case) it would require a restructuring plan to be put in place to show that the banks were not gaining an unfair competitive advantage. Consequently, explains Anthony Woolich, at Holman Fenwick Willan, last week’s announcements were no more than the usual European Commission processes kicking in — albeit in exceptional circumstances. “The commission is required to act ‘proportionately’ and the divestments mean that there will opportunities for three new banks to come into the market to create new choice for consumers,” he says.

Certainly, the British Government showed no sign of being unhappy. Alan Riley, of the City Law School at City University London, points out that the British (by contrast with the French or Germans) are not normally well disposed towards state aid. So when it does arise — and is given the backing of the European Commission — the UK is keen for the rules to be followed. It was no surprise then that there was not a bleat of complaint from the British Government — nor even from the Eurosceptic Conservative Opposition. This was the state aid rules working as intended — indeed actually with some extra generous interpretation from Kroes.

Some observers, though, read more into Kroes’s actions than merely the playing out of established procedures. Instead, they saw it as an attempt by the European Commission to fill the vacuum that has been created by a decade of light-touch regulation and to give a steer to the future development of the financial services industry.

Marc Hansen, of Latham & Watkins, is one of those who was surprised by the detail of the package of restructuring and other measures stipulated by the European Commission. “The UK announcements [about what would be required of RBS and Lloyds] show that the commission is more interventionist in the banking sector than many might have expected some time ago,” he said. “It is effectively ordering wide-scale divestitures, in particular of non-core banking assets.

“Reducing concentration in the banking sector in a number of national markets is a key objective of the commission as set out in August. The real question is whether the commission as a competition regulator is the right body to be masterminding the restructuring of the banking sector across Europe. In many other countries this would be the task of financial regulatory bodies and government departments. Clearly the commission is well suited to judge the new competitive landscape — but is it also in a position to judge the other aspects?”

In effect then, some lawyers suspect Kroes was intent on more than just applying the rules on restructuring to meet the state aid requirements. And that may have been the view, too, of Stephen Hester, the chief executive of RBS, who was reported to be unhappy about the obligation to sell off the non-core banking assets of Direct Line and Churchill.

Indeed, it could be said that the direction of Kroes’s thinking had been evident for some time. As long ago as June she had told a meeting of the British Bankers’ Association that “significant divestments” would be needed by Lloyds and RBS. In particular, RBS, she said, had become “too big to supervise, too big to operate and too complex to understand”.

That looks like a judgment about “regulation” rather than the restoration of a level playing field or the removal of unfair advantages from the bail-out beneficiaries. Moreover, in recent months, other continental banks — such as ING — had also been cut down substantially in size by Kroes through stripping out their non-core banking businesses.

There may be implications here for the debate about the future of the Financial Services Authority. Rosali Pretorius, of Denton Wilde Sapte, says: “The FSA’s objectives are to manage consumer protection, risk and confidence in the markets and to reduce financial crime.” Its record on these is not good — so maybe Kroes is pushing at an open door to be the de facto regulator of Europe’s financial industry.

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