Sir John Vickers, chair of the banking commission, proposes shielding retail units from the riskier investment units.
Britain’s banks should ringfence retail and riskier investment units at an annual cost of as much as £7 billion with the aim of protecting taxpayers from future financial crises, according to a report on banking reform published on Monday.
In a far-reaching overhaul of the banking industry, the Independent Commission on Banking (ICB) stepped back from stipulating where each bank must set the ringfence, instead allowing lenders a degree of choice. The ringfenced entity must also have its own board of directors.
The ICB chaired by Sir John Vickers also said banks most boost capital levels by holding onto at least 10 percent of their retail banking operations.
The government backed the proposals, saying they would help boost the economy and protect taxpayers.
"The chancellor considers it to be an impressive report and an important step towards a new banking system that supports lending to businesses and families, supports the economy and jobs, but does not cost the taxpayers billions of pounds when it goes wrong," a government spokesman said.
However anticipating the outcome of the report, the British Chambers of Commerce, a business lobby group, warned that the broader economy could suffer from the ICB's proposed reforms.
"There are real concerns that ring-fencing may limit banks' ability to lend to small businesses," BCC Director General John Longworth said in a statement early on Monday.
As foreshadowed, the ICB wants banks to put a "ring-fence" around their core retail banking operations. Consumer deposits and small business lending must be inside the cordon, but banks will have some flexibility on what else should be included.
The ICB said "an extended implementation period would be appropriate" for the reforms, but they should be completed by 2019.
Britain set up the ICB last year to examine ways to ensure taxpayers do not bear the brunt of future banking crises.
The credit crisis resulted in Britain fully nationalising Northern Rock and part-nationalising Royal Bank of Scotland and Lloyds. The government now has stakes of 83 percent and 41 percent in RBS and Lloyds, respectively.
Britain's "Big Four" banks - Barclays and HSBC as well as Lloyds and RBS - have fought hard against excessively tough new regulation and are expected to continue lobbying now the ICB's report is out.
The government has the final say in deciding what to implement into law. Britain's banks form a powerful lobbying group since financial services are estimated to contribute some 10 percent to the UK economy.