The Chancellor is today set to announce that the Government is stepping up its investigation into competition in the retail banking market in an attempt to seize control of the issue from Brussels and the Conservatives.

Alistair Darling will highlight competition as part of the Treasury’s eagerly awaited White Paper on financial regulation, which will examine new rules to prevent a re-run of the banking crisis.

The City has become increasingly jumpy about asset sales being imposed on banks after Neelie Kroes, the European Competition Commissioner, last week issued a robust warning that Europe was going to crack down on Lloyds and Royal Bank of Scotland (RBS), both the subject of multibillion-pound bailouts by the UK Government.

Ms Kroes said that state assistance has distorted the market and both banks will have to agree to “carve-outs” of parts of their business.

The Government is likely to argue that it plans to enhance competition through measures such as making it easier for customers to switch current accounts, as opposed to directly forcing banks to sell off assets.

By focusing on giving customers more choice, the Treasury is hoping to avoid accusations of making a U-turn on Lloyds' takeover of HBOS — a deal that was brokered by Gordon Brown. However, many bankers believe that Lloyds will eventually be forced to sell off assets.

The Prime Minister waived competition rules last September to allow Lloyds to merge with its rival HBOS, when it was teetering on the brink of collapse. The deal created a mammoth bank, with almost one third of the market in current accounts and mortgages.

The merger of Lloyds and HBOS wiped billions of pounds off Lloyds’ share price and enraged its shareholders, forcing Sir Victor Blank, the bank's chairman, to announce his resignation.

Mr Darling is expected to tell Parliament as he unveils the Treasury’s plans for regulatory reform that the Government’s first concern is still financial stability, as banks are continuing to struggle with mounting bad debts and funding difficulties.

He will add that in the light of the huge market share created by the mega-merger, plus the demise of Northern Rock and the weakening of RBS, the Government is considering whether consumers are getting a fair deal from their high street banks.

The Treasury’s paper on financial regulation is likely to contain a package of measures to help consumers understand what products they are buying by enhancing financial education and independent advice.

There will also be an extensive discussion of ways to prevent a repeat of the banking crisis. The Treasury is trying to thrash out plans with the Financial Services Authority (FSA) and the Bank of England to create a better regulatory system.

The proposals will include forcing banks to link bankers’ pay to actual profits booked rather than to revenue generation, which can encourage individuals to take excessive risks.

It is understood that the White Paper on financial regulation will also include proposals that would allow the FSA to impose caps on bank debt levels.

Meanwhile, the UK is waiting for the European Commission to rule on whether its plan to pump an extra £3 billion into Northern Rock to kick-start lending is allowable under the Commission’s state aid rules.

This autumn, the Government must submit to the Commission its restructuring plans for Lloyds and RBS, which will see the banks between them spin off almost £600 billion of toxic assets into a taxpayer-funded insurance scheme.

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