Britain's high street banks threatened yesterday to pass on to their customers the multibillion-pound cost of the Government's proposed protection scheme for savers.

The Chancellor outlined reforms designed to prevent a repeat of the Northern Rock crisis. In a 162-page consultation document, Alistair Darling proposed that banks pay upfront into a scheme that ensures customers who lose their savings in a bank collapse can be compensated within a week.

Thousands of customers stripped cash from Northern Rock accounts after news broke last September that the Newcastle bank had obtained an emergency loan from the Bank of England. The meagre compensation available under the existing scheme and the prospect of waiting years before receiving any payment fuelled the run on the Rock.

But Britain's biggest banks gave warning that an upfront scheme “would not come without a cost”. A source at one bank said: “The levels of money needed would be material even to the biggest banks and very significant for the smaller ones. We would be forced to pass it on to all customers, retail and corporate.”

A source at another leading bank said: “Banks could not bear the cost on their own, it would come down to the consumers ... they would have to pay with interest rates.”

America's deposit protection scheme has a $50billion compensation pot, built up over many years, but bankers pointed out that even this sum would barely be sufficient to cover the £25 billion deposit base held by Northern Rock at the start of the bank run. There are about £1,000 billion in deposits sitting in British banks.

Customers are guaranteed to receive back all savings up to £35,000 under the existing UK compensation scheme, although the Financial Services Authority is consulting on changes to this limit.

The British Bankers' Association said yesterday that problems with the UK banking system were rare - the Rock was Britain's first bank run in more than 100 years - and that the costs of setting up the compensation scheme were out of proportion with the risk of a bank collapse.

The Treasury yesterday proposed that the emergency funding of a financial institution be kept secret until its rescue is complete, to prevent a Rock-style collapse of confidence once the bank's loan becomes public knowledge. The consultation document also proposes that the Government should be granted powers “to take temporary ownership of all or part of a bank as a last resort”, to transfer a bank's business to a third party and to take control of all or part of a bank by setting up a “bridge bank”.

As an early warning system, banks will be required at short notice to give the authorities details of their liquidity to reduce the likelihood that they will get into trouble. At present the focus is on a bank's capital assets.

Banking regulation in the UK is overseen by the Treasury, the Bank of England and the Financial Services Authority (FSA). But yesterday's reforms include the implementation of a version of the “Cobra” system used for dealing with terrorist attacks and civil emergencies, which would give the Chancellor the final say on which remedies should be used to rescue a bank.

Under Cobra, various authorities give their advice but the final power rests with the Prime Minister or the Home Secretary.

The Treasury hopes to sell Northern Rock to a private bidder, with the Virgin Group and Olivant, a consortium led by Luqman Arnold, the former Abbey chief executive, leading the race. Northern Rock has also proposed a solution led by its existing management. However, the Government drew criticism for refusing to rule out a temporary nationalisation of Northern Rock while the sale goes ahead.

The consultation period on the proposals runs to April 23 before legislation is introduced in summer.

Preventing a Northern Rock repeat

— The Government will have power to move a bank’s business to a third party

— The Government can take temporary ownership of all or part of a bank

— Bank of England will be able to give secret financial assistance to troubled banks

— Banks must be ready to provide the Financial Services Authority (FSA) with liquidity information at short notice

— FSA to obtain and share confidential bank information with the Treasury and Bank of England

— A requirement for Bank of England to produce weekly returns is to be scrapped

— A “special resolution regime” to be set up to oversee the orderly resolution of a failing bank

— Depositors compensated within a week

— Banks to pay upfront into a compensation scheme

— Government uses a version of the “Cobra” system to give the Chancellor final say on bank rescue plans

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive