Speaking at the Royal Society of Arts today, Osborne said: “We need to think deeply about whether we can sustain banks that are not only too big to fail, but potentially too big to bail.
“Not only do large financial institutions do more damage when they get into trouble, but their very size and “too big to fail” status may encourage them to behave irresponsibly and take risks that smaller banks dare not take.”
Osborne said Prime Minister Gordon Brown was wrong to have ruled out more fundamental changes to the future structure of the banking industry.
He said the Office of Fair Trading was right to highlight the reduction in competition between banks as a consequence of banks merging or withdrawing from the market due to the economic downturn.
He said: “By dint of its substantial shareholdings the Government has a powerful influence over the future structure of the UK banking industry, whether it likes it or not.
“When the time comes to sell off those shareholdings we need to think very carefully before simply selling them to the highest bidder without thinking through the consequences for the wider economy.
“We should look at whether Britain in fact needs smaller banks.
“For it would be a bitter irony if we came out of this crisis with a banking system that was even more concentrated and even riskier than the one we had before it.”
Osborne also said the Tories are considering Sir James Sassoon’s recommendation to give the Bank of England powers over the FSA on individual financial institutions if financial stability is threatened.
He added that the macro-prudential regulator should be located in the BoE and not in the FSA as argued by chairman Lord Adair Turner.
Osborne said: “It used to be said that one twitch of the Governor’s eyebrows was enough to force unruly bankers into line – well we will give the Governor back his eyebrows in a way that suits modern financial markets.
“That means locating the macro-prudential regulator in the Bank, not the FSA as Lord Turner argues.
“And it’s why we are considering the option set out by Sir James Sassoon, in the review of the tripartite system I asked him to conduct, of giving the Bank back-stop powers to step in over the head of the FSA and impose its will on individual financial institutions if financial stability is threatened.”