UK FSA's Bailey says banks still "too big to fail"

LONDON, Oct 4 (Reuters) - The failure of one Britain's big banks would still wreak market havoc and leave taxpayers on the hook as more needs to be done to curb their complexity and risks, the country's top banking supervisor said on Thursday.

A core lesson from the 2007-09 financial crisis is the need to make it easier for a big bank to fail in an orderly way to avoid taxpayer bailouts and the markets meltdown seen when Lehman Brothers crashed in September 2008.

"For large banks, we are making progress on resolution planning, and this world is different from five years ago, but we are not there yet by any means," said Andrew Bailey, director of UK banks at the Financial Services Authority (FSA).

The FSA and the Bank of England, which will take over supervision of banks next year, are checking the recovery and resolution plans of top lenders HSBC , Barclays , Lloyds and RBS .

These "death plans" must convince Bailey they can be wound down in an orderly way, a goal that benefits consumers too.

"Put simply, if we don't know how to deal with a failed firm, we will inevitably set a higher barrier to entry. This is what we see in the banking industry," he said in a speech to the Edinburgh Business School.

Britain will force its deposit taking banks to wrap their commercial arms with more capital and shift riskier operations to investment banking units.

Bailey said proprietary trading - where the bank takes bets on the market - should not be housed in the commercial arm.

Banks were becoming more resilient but credit growth in the UK economy continues to be weak and it was too early to say if the Funding for Lending Scheme to boost credit works.

In the meantime, banks can shrink the capital buffers they hold over the minimum requirements, and trim their cash-like liquidity buffers to help increase lending, Bailey said.

(Reporting by Huw Jones; Editing by Mark Potter)

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