The ring-fencing of retail banking was the key proposal put forward in an interium report published today by the Independent Commission on Banking (ICB).
Banks should also provide more consumer choice by making it easier for customers to switch accounts, as well as ensuring that ordinary depositors are less exposed to failure than unsecured creditors, according to the report.
Meanwhile a 10 per cent equity baseline should become the international standard for systemically important banks and should be applied to large UK retail banks, regardless of whether it is universally adopted, the commission recommended.
According to the ICB the creation of the Financial Conduct Authority (FCA) was potentially a "vital spur" to creating this competition in banking, as it will have regulatory tools not available to the general competition and consumer authorities.
A statement from the report said: "Ring-fencing a bank’s UK retail banking activities could have several advantages.
"It would make it easier and less costly to sort out banks if they got into trouble, by allowing different parts of the bank to be treated in different ways. Vital retail operations could be kept running while commercial solutions – re-organisation or wind-down – were found for other operations."
The ICB has made the recommendations in advance of its final report, which will be published in September. In the meantime the Commission will consider views and responses to the proposals.
The reference to Lloyds Banking Group follows its acquisition of HBOS, which has resulted in the bank holding a 30 per cent market share of UK current accounts.
Lloyds is currently preparing to sell 600 branches to satisfy EU competition laws as part of it government bail out.