Britain's top banks should shield their retail operations from riskier investment banking activities and hold more capital to protect taxpayers in the event of another financial crisis, a report said.

Radical shake-up proposals outlined on Monday appear harshest for Lloyds Banking Group, which may be forced to sell hundreds more branches in addition to the 600 already on the block.

The recommendations, compiled by a powerful independent panel, are not as severe as many bankers had feared, but it would force HSBC, Barclays and peers to hold billions of pounds more capital and squeeze profits.

Those banks have threatened to quit London for New York or Hong Kong if regulation becomes too onerous, but the proposals from the ICB were not as potentially costly as some had feared and the Commission said they should have a broadly neutral effect on financial services.

The biggest surprise is the fact that they're going to re-examine the scope of the Lloyds divestments, said Oliver Bretz, managing partner of the global antitrust group at Clifford Chance.

The comments on ring-fencing and Tier 1 capital are less of a surprise.

The big universal banks should hold capital separately for their UK retail banking operations, as well as for their businesses as a whole, the ICB said.

That would better protect retail operations if an investment banking arm hits trouble, and reduce the risk that taxpayers will need to bail out a riskier parts of a bank.

BRANCHES SALE?

The report said Britain's banks should hold core Tier 1 capital of at least 10 percent, compared to new global rules of 7 percent, although the Commission said this should be a baseline international standard for systemically important banks. There had been fears the banks would be told to hold more.

The ICB, headed by Oxford academic and former Bank of England interest rate setter John Vickers, was tasked with considering structural reforms to reduce risk and promoting competition.

More needs to be done to combat lack of competition on the high street as Lloyds' takeover of HBOS left it with a 30 percent share of the current account market, for example.

Signaling hundreds more branches need to go, the report said Lloyds' sale of 600 branches would have a limited impact on competition unless it is substantially enhanced.

Vickers and his team stopped short of the nuclear option of unwinding Lloyds' takeover of HBOS, but said: There is cause for regret that the government in 2008 amended competition law to facilitate the Lloyds TSB/HBOS merger but the facts in 2011 have to be taken as they are.

Enhancing the divestiture would be more economically efficient than reversing the Lloyds TSB/HBOS merger, it added.

Lloyds said it was assessing the full implications of the report and would update the market once it had reviewed the report in detail.

It will be up to the government to choose how much of the ICB's proposals to implement, and banks are already lobbying hard to limit the scale of reform.

(Reporting by Sudip Kar-Gupta, Steve Slater, Paul Hoskins and Sarah White; editing by Sophie Walker)

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