BANK of England Governor Sir Mervyn King has predicted that bank bosses could eventually decide to split up their institutions, even though planned reforms stop short of this.

But he also warned that the new set-up could be undermined unless regulators are protected from bank lobbying.

The Government plans to force banks to ring-fence their retail banking businesses from higher-risk investment banking arms.

Loading article content

Sir Mervyn supports complete separation of the two forms of banking and predicted that falling investment banking profits could prompt institutions to pursue a split.

"The economics of investment banking have changed radically. It may well be that the nature of banking looks very different and separation may emerge as the natural outcome," he said.

He added that the changing dynamics might prompt bank bosses to reform their organisations' cultures, which he believes have been affected by the aggressive ethos of investment banking.

Sir Mervyn, however, also called for the new banking rules and powers to be clearly defined to protect regulators from lobbying and the ring-fence being undermined.

He suggested banks would be able to get around the new rules if the interpretation of the separation depended on negotiations between the banks and the regulators.

Sir Mervyn's comments echo warnings about the lobbying power of banks from other senior regulators, Financial Services Authority chairman Lord Adair Turner and the FSA's banking division head Andrew Bailey earlier this week.

The views of Sir Mervyn, who retires next year, are not wholly shared by Paul Tucker, the deputy Bank Governor seen as the frontrunner to succeed him. Mr Tucker said he does not back splitting banks completely and said the system could still be "blown up" by the collapse of financial institutions that are not banks.