Britain's top financial regulator today set himself on a collision course with the Bank of England after warning that forcing banks to slim down would prove too problematic.

Addressing the Treasury Select Committee today, Lord Turner, the chairman of the Financial Services Authority, dismissed suggestions made last week by Mervyn King, Governor of the Bank of England, that if a bank was too big to fail, it was simply too big to operate.

Lord Turner said that he favoured an approach where larger banks would be forced to hoard more capital to absorb the shock of risky trades. The difference of opinion between Mr King and Lord Turner sits at the heart of a debate among politicians and regulators over whether to compel banks to carve themselves up to separate retail and investment banking divisions.

After Lehman Brothers, the Wall Street investment bank, went bust in September last year, financiers, regulators and polticians have worried over the extent to which the stability of the global financial system can be threatened by the collapse of one large lender.

Lord Turner said: "I am therefore significantly attracted to ideas in [US Treasury Secretary] Geithner’s proposals that we should think about not an absolute limit on size, that would be very dfficult to achieve, but a sliding scale of capital requirements which simply require higher capital requirements from large banks or from banks involved to a greater extent in risky trading. It’s a tax on size.”

Lord Turner said that he knew that banks had already warned shareholders and analysts that new requirements to beef up their capital reserves would hit investment returns.

He added: “We could end up saying we are going to limit the size of proprietary trading activity that can be done within the same legal entity. I would not exclude that."

The City regulator also cautioned MPs that he suspected that both banks and economies had failed to learn their lesson from the credit crisis, which brought the British banking system within hours of total collapse last year.

He said: "I’ve certainly noticed there is aggressive hiring going on, particularly in the trading activities of the investment banks. There’s a real danger we don’t seize the opportunities of this crisis. Internationally we could fail to be radical enough to respond to what has occurred.”

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