By Huw Jones

LONDON (Reuters) - Breaking up banks to legally separate retail from investment banking could increase risks in the system and higher capital is key, the Financial Services Authority said on Monday.

Adair Turner, chairman of the FSA, said there was no "silver bullet" to tackling the so-called "too big to fail" issue with systemically important banks.

Tougher capital rules must form the core of regulatory responses even if scrutiny of banks is more intense, he said.

"Our ability to see bumps in the road ahead is imperfect so we need more shock absorbers," Turner told an FSA conference.

"The extreme narrow banking proposal is clearly doable in practical terms, a law could be passed which achieved this effect, but I believe would fail to address the most vital problem and could produce a financial system even more vulnerable to instability than today's," Turner said.

"Such a division would clearly not be a policy response sufficient in itself," Turner added.

The G20 group of leading countries agreed in September that all systemically important financial institutions should have contingency plans in place for a speedy, orderly wind up by the end of 2010.

Such plans are expected to focus on so-called living wills in a bid to lessen the need for public bailouts in future. Banks fear they will be forced to simplify their structures and face prohibitively heavy capital charges on risky activities such as trading.