The Government has revealed plans to protect savers' money in the event of a bank collapse, including a controversial idea to split High Street (BSE: HIGHSTREE.BO - news) banks from their riskier investment divisions.
The plans are designed to prevent a repeat of the financial crisis and the need for future taxpayer-funded bailouts but industry analysts have warned they could spell the end of so-called "free banking".
The proposals are based on the recommendations of the Independent Commission on Banking (ICB) which said in a report last year that the deposits of ordinary customers and small businesses should not be used to fund speculative investments such as those which led the banking crisis.
In a joint statement by the Chancellor George Osborne and the Business Secretary Vince Cable they said: "A robust ring fence, separating investment banking and related activities from more traditional personal and business lending, is vital to reduce structural complexity and to make banks easier to resolve in crisis, where speed of execution is vital.
"The reforms proposed here will ensure that we meet the challenge of the British Dilemma, namely how to remain a successful global financial centre without asking taxpayers to bear unacceptable risks."
In legislation proposed by the Treasury, banks will be forced to separate their investment banking divisions from traditional personal and business lending into what it calls a "ring fenced" bank.
The ring fenced bank must be independent, have its own risk committee and hold its own cash reserves so it would be unaffected by the collapse of its sister investment bank.
But it will be allowed to offer "hedging" investment products to small businesses that help them insure against currency fluctuations and changes to interest rates.
Ordinary depositors would also be first in line to get their money back in the event of a bank's collapse leaving other stakeholders such as bondholders and shareholders to share what remains.
British banks will be required to hold reserves worth 17% of their liabilities to ensure it can continue trading in the event of a bank funding crisis, such as that which led to the collapse of Northern Rock and threatened other banks in 2008.
New rules to make it easier for customers to switch between banks are due to come into effect in 2013.
The Chancellor will outline his proposals in a speech to City grandees at Mansion House in London tonight along with the governor of Bank of England, Sir Mervyn King.
The banking industry has resisted the reforms arguing they will push up the cost of doing business and that higher costs will have to be passed on to customers who have grown accustomed to free banking services.
Britain's biggest bank, HSBC (LSE: HSBA.L - news) , has threatened to move its headquarters elsewhere if the government proceeds with new rules that will disadvantage it in competition with international rivals.
Professor Philip Booth from Cass Business School said: "It is important that George Osborne does not impose costly policies that will have no benefit.
"The ring-fencing of deposit-taking and other banking functions from each other is largely irrelevant and may drive banks away from the UK."
The reforms are contained in a White Paper which will remain open to further consultation before draft legislation is written in the autumn.
The wider reforms are expected to be written into law before the next general election in 2015 but the ICB has recommended giving banks until 2019 to implement them.
Business consultants Deloitte have welcomed the long awaited publication of the government's intentions.
David Strachan, co-head of the Deloitte centre for regulatory strategy, said: "So far, banks are understandably holding off committing to the design of a ring-fence that may ultimately not meet the Government's criteria.
"Given the complexities and execution risks involved in restructuring of this magnitude, it's essential that banks and investors first get the clarity they need and then there is enough time for the banks to implement all this properly."