Lord Turner of Ecchinswell, chairman of the Financial Services Authority (FSA), the City regulator, called today for an effective "tax on size" for large banks that are deemed too big to fail.

In a speech at the second FSA conference held to discuss his Turner Review on bank regulaton, published in March, he said that banks such as Royal Bank of Scotland and Lloyds had been kept alive by huge injections of government capital because they were seen as too big to let them go bust. He said that a possible answer to this would be to force larger "systemically important banks" to hold larger amounts of capital.

Lord Turner said: "Essentially, such measures amount to a tax on size or on other measures of systemic importance. If, despite them, large and complex banks remain competitive, that is fine because they will be safer; if, in response, banks choose to remain smaller and simpler, that is fine also.

"In the past, as I have shown, we actually allowed larger banks to operate with slightly lower capital requirements; we need to reverse that approach. We are committed to higher capital across the whole banking system, but there is also a strong case for demanding higher-still capital standards from our largest systemically important banks."

The FSA chairman said that there was no one "silver bullet" for addressing the problem of banks becoming too big to fail, but that such a tax and several other key measures would be a better method than drawing up laws to separate investment banks and retail banks.

Lord Turner said that national regulators should look at an individual bank's national subsidiaries and force each one to hold higher capital, avoiding one regulator having to control a global bank from the country from which it is headquartered.

A third suggestion was to "dramatically reduce interconnectedness in wholesale traded markets, via the use of central counterparties and better capital and margin arrangements for bilateral contracts".

Lord Turner also said: "We need a fundamental review of the trading book capital regime and a bias to conservatism for riskier and purely proprietary activities."

All these actions, he said, could lead to something close to a separation of investment banks from retail banks, without the need for imposing a legal separation that "could produce a financial system even more vulnerable to instability than today’s”.

Referring to moves by international bank-regulation bodies, Lord Turner said that reforms of the capital regime for banks "are now being considered by the Basle Committee and the FSB, and will themselves make a very major contribution to addressing the ‘too-big-to-fail’ problem".

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