Tories vow to tighten bank regulation

Sweeping changes to the way Britain's banks are regulated would be introduced by a Tory government in an attempt to avoid a repeat of the financial crisis. They will modelled on a report to be published today which calls for the break-up of the Financial Services Authority (FSA) and handing back the job of regulating the financial sector to the Bank of England.

The issue could become a key dividing line at the next general election. Gordon Brown may be reluctant to break up the FSA because he set it up as Chancellor in 1997, when he took responsibility for regulation from the Bank.

Senior Tories said they would look very seriously at today's 80-page blueprint by Sir James Sassoon, a former senior Treasury official under Mr Brown, who was asked to investigate the regulatory system by the shadow chancellor George Osborne. Sir James called for a "major overhaul" of the system, in which responsibility is shared by the FSA, the Bank and the Treasury, saying it had not brought financial stability.

He said last night: "At the very least, the FSA needs a major internal reorganisation to put prudential regulation at the heart of the organisation. But we should also look at more radical options including breaking up the FSA and moving aspects of institutional regulation back to the Bank of England."

His report argues that the FSA focused excessively on the conduct of business regulation at the expense of prudential regulation. As a result,it failed to prevent individual institutions putting the stability of the entire system at risk.

Mr Brown will come under pressure this week over his role in last autumn's merger between Lloyds and HBOS, after a second government bailout of the Lloyds Banking Group. The Government's stake will rise from 43 to up to 77 per cent in return for insuring £260bn of the bank's toxic assets.

Brown aides insist that the two banks were intent on the merger. But opposition parties accused the Prime Minister of trying to get the credit for brokering the deal at the time, saying he could not walk away from it now.