UPDATE 1-UK sets out new law to break up errant banks
* New laws will make banks ring-fence retail operations
* Break-up threat in place if banks try to flout new laws
* Government would make final decision over break-ups
* BoE will monitor banks to make sure they adhere to rules
LONDON, Feb 4 (Reuters) - British banks that fail to guard their day-to-day banking from risky investment activities will face being dismantled, finance minister George Osborne will say on Monday.
Britain is shaking up its system of bank regulation following the 2008 financial crisis, when the government poured 65 billion pounds ($102 billion) of taxpayers' money into rescues of Royal Bank of Scotland and Lloyds Banking Group.
Banks were already expected to have to "ring-fence" activities such as standard bank accounts and payments from riskier investment banking, something which will hit major players such as Barclays, HSBC, and RBS.
But Osborne said he is prepared to go further. "If a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether - full separation, not just a ring-fence," he said in excerpts of a speech he is due to give later on Monday.
"In the jargon, we will 'electrify the ring fence'," said Osborne, according to the excerpts released by his office.
The break up of banks which fail to keep to the rules was demanded by lawmakers who reviewed government plans late last year.
Under the new rules, the Bank of England will be responsible for monitoring whether banks ensure that risks taken by their investment banking arms do not endanger their retail sides.
If the central bank finds a breach, the government will make the final politically-sensitive decision on whether to impose a "nuclear option" of forcing banks to sell one of the two arms.
Banks have come to accept the idea of a ring-fence, having initially resisted it. A source close to one of Britain's biggest lenders said the industry's main concern had been to have clarity over what future regulation will involve.
Britain's banks have been dogged by scandals including the mis-selling of insurance and complicated hedging products, the rigging of global benchmark rates and breaches of anti-money laundering rules.
The source said that, with lenders already under intense scrutiny, Osborne's decision was a longer term move designed to prevent banks letting standards drop when attention is less focused on the industry.
Antonio Horta-Osorio, chief executive of Britain's biggest retail bank, Lloyds, had previously welcomed the ring-fencing proposals, saying it would lessen the chances of taxpayers' money having to be used again to bail out UK banks.
"It is right for the economy because it will ensure safer, more stable retail banks without having to further increase the capital and/or liquidity requirements," he said in December.
Legislation will go to parliament later on Monday, and in his speech Osborne is also expected to detail new rules on limits to banks' leverage.
Under the most recent plans, leverage was to be set at 33 times banks' capital, weaker than an original proposal for a maximum of 25 times.
In December, a cross-party group of lawmakers reviewing the plans said it was "not persuaded by the government's relaxation" of the leverage rule and added that the Bank of England should set the leverage cap.
The opposition Labour Party said it was concerned that Osborne would not revert to the original proposal, and also that breaking up banks would only be possible on a bank-by-bank basis, rather than for the entire industry.
"If ... the Chancellor is planning to stop short on both the backstop powers and legislation for the leverage ratio, then there will be a very real sense ... that despite all the rhetoric the Chancellor hasn't got the appetite for the radical banking reform we need," Labour lawmaker Chris Leslie said.
But Osborne -- who will deliver his speech at U.S. investment bank J.P. Morgan's offices in the southern English city Bournemouth -- insists his reforms strike the right balance between responding to public anger and avoiding a populist overreaction.
"Our country has paid a higher price than any other major economy for what went so badly wrong in our banking system. The anger people feel is very real. Let's turn that anger from a force of destruction into a force for change," he says.
"Any bunch of politicians can bash the banks ... but what good would that do our country? The jobs, the investment, the banking system we all need would go with it."
Osborne will begin his speech at 1100GMT.