LONDON (Reuters) - Britain should adopt legislation that could force all banks to split routine retail operations from riskier investment activities if new rules designed to protect taxpayers fail, an influential parliamentary panel said.
Any decision would have to be recommended by an independent review and the final decision to act on an industry-wide basis would lie with the government and parliament, not with the regulator.
The Parliamentary Commission on Banking Standards, which has been asked to find ways to reform banks, also said on Monday that Britain's financial regulator should be given the responsibility to decide how far banks can leverage their capital for investment and lending.
The government's Banking Reform Bill is due to be debated in parliament on Monday. But Conservative MP Andrew Tyrie, who heads the commission, said that current proposals to change the industry fall short of what is required.
"There remains much more work to be done to improve the bill," he said in a report published ahead of the debate.
Britain is determined to prevent a repeat of the need for taxpayer-funded bank bailouts after the 65 billion pounds double rescue of Royal Bank of Scotland (RBS.L) and Lloyds Banking Group (LLOY.L) in 2008.
The commission was set up amid public outcry after Barclays (BARC.L) was fined for rigging global interest rates, the latest in a string of banking scandals including the mis-selling of loan insurance and complex interest rate hedging products to small firms.
Chancellor George Osborne said in February he would take up a recommendation made by the commission that any individual bank that tried to find a way around the new laws could be broken up by the regulator.
All the leading British banks, including Barclays, HSBC (HSBA.L)(0005.HK) and RBS, will be affected by the legislation.
The industry, however, has warned that the severity of the proposed reforms - more rigorous than those in France and Germany - could put British banks at a disadvantage against continental rivals such as Deutsche Bank (DBKGn.DE) and BNP Paribas (BNPP.PA).
"This will create uncertainty for investors, making it more difficult for banks to raise capital, which will ultimately mean that banks will have less money to lend to businesses," the British Bankers' Association (BBA) said last month.
The BBA's plea appears to have held little sway with the commission and Tyrie said that a "second reserve power for full, industry-wide separation" needed to be included.
"The bill would be strengthened by making specific provision to consider the case for full, industry-wide separation if the ring-fence is judged to be failing. As is appropriate, the final decision would lie with the government and parliament and not with the regulator," the commission said in its report.
It is recommending a periodic review of whether banks are sticking to the rules.
Among the proposals to rein in risk-taking is the leverage cap. The commission wants this set at 25 times banks' capital. The government wants a weaker cap of 33 times capital, which the commission's report said is "unlikely to provide a robust enough backstop".
The commission called on the government to delay pushing through the Banking Reform Bill until its final report is published in May.
"The task of sorting out the banking industry, of which this bill will form a major part, is absolutely essential for the long-term health of the British economy. Let's get it right," the commission said.
(This story is corrected to clarify basis on which banks could be split in headline and in first, second, eighth, 12th and 14th paragraphs)
(Editing by David Goodman)