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London - Britain's biggest banks will face being broken up if they fail to ring-fence their retail and investment arms, under draft legislation set to be announced by finance minister George Osborne on Monday.
The new law will empower the government and a new banking watchdog to "electrify the ring-fence" if banks refuse to separate high-risk operations from savers' deposits.
Launching the Banking Reform Bill, Chancellor of the Exchequer Osborne was due to say that banks will no longer be able to become "too big to fail", forcing the taxpayer to bail them out.
The government had already announced plans to force banks to ring-fence operations by 2019, in a bid to avoid taxpayers having to bail out troubled banks as was the case during the financial crisis.
But the draft law has been toughened up to include "electrification" of the ring-fence after the Parliamentary Commission on Banking Standards complained last month that the proposals fell "well short of what is required".
Osborne had previously warned the commission against "unpicking the consensus" on structural reform of the banking sector but appears to have accepted its warning that the draft law left room for loopholes.
The announcement puts the finance minister on a collision course with Britain's banks, which claim the legislation would make London less attractive as a global financial centre.
"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," said Anthony Browne, chief executive of the British Bankers' Association.
"Above all, what banks and business need is regulatory certainty so that banks can get on with what they want to do, which is help the economy grow."
But Osborne was set to tell bankers: "When the RBS (Royal Bank of Scotland) failed, my predecessor Alastair Darling felt he had no option but to bail the entire thing out.
"Not just RBS on the high street, but the trading positions in Asia, the mortgage books in sub-prime America, the property punts in Dubai.
"I want to make sure that the next time a Chancellor faces that decision they have a choice. To keep the bank branches going, the cash machines operating, while letting the investment arm fail."
If passed, the Banking Reform Bill would also establish a new watchdog for the industry and force investment and retail banks to have separate bosses.
