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LONDON (Reuters) - Britain's opposition called on Monday for the country's big five banks to be forced to sell hundreds of branches to create at least two major competitors by 2015 and for regulators to make it easier for new retail banks to emerge.
The proposal comes as Britain's politicians argue over how best to respond to an interest rate rigging scandal that reignited public anger towards banks which many people blame for sinking the economy into recession.
"Let's break the dominance of the big five banks. Let's turn five into at least seven so there is proper choice for the consumer," Ed Miliband said in a speech at the Co-operative Bank's headquarters in London.
"The quickest way to do that is to force existing banks to sell off hundreds more branches to create the space needed for a challenger to thrive."
For years, Britain's banking system has been dominated by a handful of large lenders but many individuals and small companies say they are unable to access credit.
New entrants have already begun to emerge in the wake of the 2008 financial crisis, looking to fill the gap as the big banks focus on shrinking their balance sheets and building up capital reserves to meet new regulations.
However, barriers to entry are seen as prohibitive and new challengers must meet stringent criteria to convince regulators they have the required capital, IT infrastructure and management expertise.
Labour's finance spokesman Ed Balls wants regulators to be more open to new entrants into retail banking and to make it easier for existing "challenger banks" to grow more quickly.
"Regulators, and this includes the Treasury, have got to decide that they positively want to embrace and support new entrants," Balls told reporters after the speech.
"That doesn't mean you have to be slipshod. It's an issue about the regulatory mindset and a move away from the idea that, unless you've been doing it for 40 years, you can't know what you're doing," he said.
The government accused Labour of "jumping on the bandwagon".
"Ed Miliband and Ed Balls had 13 years to reform the banks when they were at Gordon Brown's side, but failed," said Conservative member of parliament Matthew Hancock.
"They even failed to implement their own banking competition review when they were at the Treasury - so the dominance of the big banks actually got worse under Labour."
Balls said a probe into competition in banking should be brought forward to 2013. Britain's retail banking industry is dominated by Lloyds, RBS (RBS.L), Barclays (BARC.L), HSBC (HSBA.L) and Santander (SAN.MC).
Although a fraction of the size of the top banks, challengers such as Metro Bank, Virgin Money and Aldermore have emerged while the planned sale of over 600 branches by Lloyds Banking Group (LLOY.L) to the Co-operative Group will create a competitor with 7 percent of the total market for current accounts in Britain.
Lloyds faced difficulties finding a buyer for the 632 branches it was required to sell as payback for receiving about 20 billion pounds ($31 billion) of state aid during the 2008 financial crisis.
It finally reached an understanding with the Co-op last month after rival bidder NBNK, set up by former Lloyd's of London insurance head Peter Levene, had struggled to convince Lloyds' management it would get regulatory approval.
Balls also expressed support for building societies. The Treasury said on Friday it was prepared to relax lending and funding requirements to make it easier for mutuals such as Nationwide to lend to small businesses.
"They have something quite distinctive which is that they are often very locally engaged, they're often very close to the communities that they represent," he said.
The Conservative-led coalition government plans to flood Britain's banking system with more than 100 billion pounds of cheap funding as it seeks to pump credit through an economy struggling to escape recession amid the euro zone crisis.
Miliband said it must go further and create a 'British Investment Bank' to provide loans for small companies and infrastructure and offer the credit which banks are failing to do.
"Our banking system is letting down our small businesses. Every other major country understands that government needs to act to tackle this. It's time that British business stopped having to compete with one hand tied behind its back," he said.
Miliband also proposed that a specialist banking crime unit be set up within the state Serious Fraud Office with the remit of investigating serious financial services fraud such as the rigging of the London Interbank Offered Rate (Libor).
"The revelations of the last two weeks have shown precisely what has gone wrong with our economy in the last decades. And the test of whether we can change things now starts with our banks," he said.
($1 = 0.6449 British pounds)
Editing by Robin Pomeroy