The Bank of England is examining whether Britain's biggest banks should formally separate their investment banking and retail banking operations, The Times has learnt.

News that such a move is under discussion at such a high level will send fresh shudders through the UK banking sector, still reeling from the fallout of toxic debt and the credit crunch.

George Osborne, the Shadow Chancellor, hinted yesterday that a Conservative Government would break up Britain's nationalised banks and would also consider whether to block other lenders from becoming too big.

Mr Osborne's plans would trigger the biggest change in the structure of the City since 1986, when Margaret Thatcher deregulated financial markets in a banking revolution that came to be known as Big Bang.

The Shadow Chancellor's remarks form part of a wider debate among governments and regulators about how to reduce systemic risk among the banks.

Last month, Mervyn King, the Governor of the Bank of England, gave a speech to the City in which he referred to the former American law that until 1999 separated investment and retail banking, saying: “Should there be a Glass-Steagall type of provision to prevent retail deposits from being used to fund investment banking activities?

“There are good arguments in favour, to separate the utility functions of a retail bank taking household deposits and running the payments system from the casino trading of an investment bank, and good arguments against - the difficulty of maintaining a credible boundary between those institutions that are eligible to receive government support and those that are not. We need a public and informed debate on the merits of the arguments.”

It is also understood that the US Federal Reserve is considering the feasibility of splitting up giant banking institutions to try to limit the systemic risk posed by the collapse of another large bank.

In a speech yesterday at the Royal Society of Arts, Mr Osborne said: “We need to think deeply about whether we can sustain banks that are not only too big to fail, but potentially too big to bail.”

He added: “We should look at whether Britain in fact needs smaller banks. For it would be a bitter irony if we came out of this crisis with a banking system that was even more concentrated and even riskier than the one we had before it.”

Although politicians in the UK and the US have been pressing for banks to find a way to ringfence or split off their riskier investment banking businesses, both Gordon Brown and Alistair Darling want to strengthen regulation of UK banks rather than to force them to slice themselves up.

It is understood that Mr Osborne has spoken with some institutional investors to ascertain their appetite for a new culture of smaller banks and has been given a sympathetic hearing.

In his speech, Mr Osborne said: “By dint of its substantial shareholdings, the Government has a powerful influence over the future structure of the UK banking industry whether it likes it or not. When the time comes to sell off those shareholdings, we need to think very carefully before simply selling them to the highest bidder without thinking through the consequences for the wider economy.”

The Bank and the Federal Reserve declined to comment last night.

— Barclays' investment banking unit has kicked off an ambitious global hiring spree. Barclays Capital is trying to develop a European and Asian equities and investment banking business to build on the American business it took over from Lehman Brothers. Insiders say that staff numbers at Barcap, which employs 23,000 people worldwide, will fall this year, although Barcap has hired 200 staff for its equities business. In London it has tried to poach bankers from UBS, Morgan Stanley and Credit Suisse.

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