Britain may need to cap the size of banks or fully separate their retail and investment operations to curb the risks "King Kong" lenders pose to the financial system, a senior Bank of England official said.
Andrew Haldane, the central bank's director of financial stability, said tackling "too-big-to-fail" banking is essential to end the implicit funding subsidies big lenders receive from markets betting that no government will allow them to collapse.
From 2002 to 2007, the implied annual subsidy to the world's biggest banks averaged $70 billion (43.43 billion pounds) a year, roughly half of average post-tax profits, and this could balloon to around $300 billion, Haldane said.
"Subtracting this subsidy, removing the state crutch, would suggest a dramatically lower socially optimal banking scale. Like King Kong and Godzilla, these giants would arguably then be physiological impossibilities," Haldane said.
Reforms like UK plans to hit the deposit arms of banks with extra capital requirements represent progress but "today's ring-fence can become tomorrow's string vest", Haldane said in a speech delivered on Thursday evening and made available on Friday.
"Worse, they risk sending a false sense of crisis comfort."
The Bank becomes the main regulator for UK banks from April. Haldane also sits on the Bank's Financial Policy Committee which sets the direction for regulation in Britain.
It was Haldane's second speech in recent months that questioned core global regulatory changes. In August he said the tougher Basel III bank capital rules being phased in from January were too complicated and needed a rethink.
Regulators are introducing reforms to wind down a bank without rattling markets and avoiding the taxpayer bailouts seen in the crisis, but Haldane was sceptical.
"When the call comes to ride to the banking rescue, government may be unable to afford not to," he said.
World leaders have agreed to impose extra capital requirements on the 29 biggest banks from 2016, but Haldane said this would still leave too-big-to fail largely untouched.
More far-reaching structural changes may be needed.
"Limits could be placed on bank size," Haldane said, adding that studies showed economies of scale decline for banks with assets of more than $100 billion.
Full separation of retail and investment banking, such as with the now scrapped Depression-era U.S. Glass Steagall Act, would be operationally simpler and avoid "cross contamination" of the different cultures seen in retail and investment banking.
"There may be a distance to travel before banking is the right size," Haldane said.
(Reporting by Huw Jones, editing by Chris Vellacott)