Britain's banks call on government to phase out industry levy

* Banks say government should consider sunset clause and cap

* Bank body says levy is damaging UK financial services industry

* Banks want end to uncertainty over duration of tax

* Levy was increased in March and was in election manifesto

By Matt Scuffham

LONDON, July 6 (Reuters) - Britain's banks have called upon the government to phase out the bank levy, saying it is damaging the competitiveness of the industry and causing them to lose business to overseas rivals.

The levy was initially introduced in 2011 not only to raise money but also to discourage banks from risky borrowing, replacing a previous one-off tax on bankers' bonuses by the Labour government following the 2007-9 financial crisis.

Its emphasis has changed to focus on generating revenue with Britain's finance minister George Osborne saying in March banks needed to make a greater contribution to repair the country's finances.

Osborne increased the levy in March to 0.21 percent of a bank's assets from 0.16 percent previously. That lifted the amount the government aims to raise from the tax to 3.4 billion pounds ($5.3 billion) a year from 2.5 billion.

Anthony Browne, chief executive of the British Bankers Association, said in a letter to Osborne on June 23 that the government should consider ways of reforming the tax.

"Proposals to consider could include the levy to be capped in terms of its rate and a sunset clause introduced so that banks can begin to plan for a future without the levy," he said.

The Chancellor will outline his economic plans in an emergency budget on Wednesday following May's general election. The Treasury would not comment on whether he will address the issue of the levy, which was a pledge in the Conservative party's election manifesto.

Europe's biggest bank HSBC has said the levy will be a factor in whether it decides to keep its headquarters in the UK. It plans to make a decision this year.

"The levy is already causing damage," Browne said in his letter to Osborne. "For example, activities are being booked outside London and marginal investment decisions are seeing activity placed outside the UK."

Browne said banks wanted more certainty around the issue and assurance that banks were part of broader plans to make sure the UK remained competitive on taxation.

"This is important not only from the perspective of the location of international banking and capital markets activities, but also in terms of impacting upon the provision of credit to the domestic economy," he said.

Osborne struck what some bankers believed to be a conciliatory tone in his annual speech to bankers in the City of London last month, saying he wanted Britain to be the best place for global banks to be headquartered and talking of a "new settlement" for the industry.

Other suggestions for reform of the levy have included the possibility of making it a tax on UK banking assets only, which would mean those with a high proportion of overseas assets, such as HSBC and Standard Chartered (HKSE: 2888.HK - news) , would not be unfairly penalised. ($1 = 0.6402 pounds) (Reporting by Matt Scuffham; Editing by Elaine Hardcastle)