Large parts of the City have grown too big and need to be cut down to size, if necessary by imposing new taxes, according to the chairman of the Financial Services Authority.

Lord Turner of Ecchinswell, an influential figure in the reform of banking rules in London and beyond, said that the City had grown “beyond a socially reasonable size”, accounting for too much of national output and sucking in too many of Britain’s brightest graduates.

“I think some of it is socially useless activity,” he said, adding that the financial sector had “swollen beyond its socially useful size” and seemed to make excessively large profits.

Lord Turner named fixed-income securities, trading, derivatives and hedging as areas that have grown beyond socially optimal levels, adding that fund management and share trading might also have grown too big.

Lord Turner added that he would favour City-specific taxes if his proposed new rules on capital failed to shrink investment bank balance sheets and curb the more useless or reckless trading. “If increased capital requirements are insufficient, I am happy to consider tax on financial transactions, Tobin taxes,” he told a discussion organised by Prospect magazine.

Tobin taxes were first proposed by the economist James Tobin in the 1970s as a way to curb speculation in foreign exchange markets and reduce volatility. However, such taxes could apply to other trading, including bonds, equities and derivatives.

Such taxes have rarely been introduced because of the risk that trading would simply shift to more benign regimes and that the taxes might have the unintended consequence of widening price spreads because of a reduction in volumes and liquidity. Lord Turner conceded the difficulties, saying: “The problem is that getting global agreement will be very difficult.”

In a robust argument for radical reform and thinking, Lord Turner said that the so-called efficient market theory — the notion that has underpinned regulatory thinking for decades — was “a train wreck” and minor adjustments to the existing regime were not acceptable.

He also made clear that defending the City against other financial centres was a long way down the FSA’s priority list. He said: “It’s clear to me that the FSA has to be very, very wary of seeing the competitiveness of London as a major aim, and that’s not a popular thing to say.”

Lord Turner earlier this year set out his proposals for reform of UK banking, one being that banks be required to hold far more capital to cover high-risk trading. The FSA chairman is on the international Financial Stability Board (FSB), a group of regulators appointed by the G20 to design a more stable financial system. He said that the FSB was well aware of the danger that proposals could be watered down because of lobbying from the finance industry. “Round the table, I think we have a very strong global consensus,” he said.

Angela Knight, head of the British Bankers’ Association, said that policymakers needed to be “immensely careful” before imposing new taxes or curbing City growth. “We may be just be sending jobs ... to other financial centres,” she said. “From the viewpoint of the economy of the UK, the competitiveness of London as a financial services centre is of vital importance.”

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