Independent Commission on Banking to back 'firewalls'
The commission set up to find ways to stop a repeat of the banking crisis is due to publish its interim conclusions.
The Independent Commission on Banking will stop short of supporting the total break-up of Britain's biggest banks.
But it will say "firewalls" should be set up within giant universal banks, to ring-fence risky investment banking operations from retail banking.
It will also suggest ways to boost competition among banks - particularly tackling the market power of Lloyds.
There is speculation that the banking group, which is 43% owned by the taxpayer, could be forced to sell hundreds more of its high street branches.
The commission was set up by the government last June to conduct a review after the financial crisis highlighted the need to reduce the risk of future bailouts.
Its interim report, to be published at 0700 BST on Monday, is the most important response so far to the financial crisis of 2008, says BBC business editor Robert Peston.
After further consultation, it will make its final recommendations to Chancellor George Osborne in September.Borrowing cost
The so-called firewalls will be recommended for banks such as Barclays, HSBC and Royal Bank of Scotland, which combine ordinary retail banking with investment banking.
Parts of a universal bank such as Barclays, Royal Bank of Scotland and HSBC... would always be bailed out by taxpayers ”
It means their investment banking units will find it more expensive to borrow.
Danny Alexander, Chief Secretary to the Treasury, declined to comment on the report's details ahead of official publication.
But he told the BBC's Andrew Marr programme on Sunday that the government would put the interests of taxpayers' ahead of the interests of banks when considering a bank restructuring.
"The government will take its obligations to taxpayers first. It is in the interests of taxpayers that will be uppermost in our mind in responding to this report, in taking this issue forward, not the interests of the banks," he said..
"We set up this commission because we have a serious problem which has caused enormous damage to our economy. These banks' balance sheets are five times the size of the British economy. We have to act on that and we certainly intend to."Risky investments
The commission of five economists and bankers, chaired by former Bank of England chief economist John Vickers, was tasked with considering a full-scale break-up of banks - something Liberal Democrats had called for in their election manifesto.
The concern is that universal banks benefit from an unfair government guarantee.
Markets believe the government would never allow a big retail bank to go bust because of the resulting losses to depositors and the disruption to the payments system.
But this guarantee means that the universal banks can borrow more cheaply and use that money to fund their highly profitable, but more risky, investment banking businesses.
The new firewall arrangement is intended to eliminate the possibility of losses at the investment banks being borne by the public purse.
It is expected that the commission will recommend requiring the banks to put their investment banking operations into a separate subsidiary company that they own.
The subsidiary would have its own capital, which could be used by it to absorb losses, but which would be allowed to go bust if it became insolvent.Rating downgrades
Barclays' chief executive Bob Diamond was bitterly opposed to the move in evidence he gave to the Treasury Select Committee in January.
It would force the banks to raise more capital for their investment banks, something the banks see as expensive and painful.
Some analysts believe Barclays has most to lose from any radical changes as its investment bank has earned more than £7bn ($11.47bn) in the last two years, or two-thirds of group profits.
And the financial markets are likely to see the ring-fenced investment banks as riskier credits, making it more expensive for them to borrow and undercutting their profits.
Rating agencies will be looking carefully at the report to understand how it affects the chance of banks being rescued by the government in future financial crises.
One agency, Moody's, said on Thursday that it would review ratings for 19 UK banks this year in light of the tougher regulatory environment, with many likely to face large downgrades.
The ring-fencing may mean rating agencies give investment banks separate - and lower - credit ratings than their parent banks.
However, critics may question whether the move will achieve its intended purpose.
It is unclear how strictly a retail bank would be restricted from supporting its investment bank - for instance through loans, guarantees or capital injections during a financial crisis.
Moreover, some may query whether the government itself would refuse to rescue a big investment bank during a financial crisis.
Former US Treasury Secretary Hank Paulson was heavily criticised for allowing the investment bank Lehman Brothers to fail, sparking the global financial crisis in September 2008.