Paul Volcker, a former head of the US central bank and an adviser to president Obama, said plans to ringfence the casino investment banking arms of major banks from their high street operations would encourage bosses to seek loopholes to take bigger risks.
In a submission to the Parliamentary Commission on Banking Standards, Volcker said a ringfence was complex and difficult to regulate compared with simply splitting investment banking operations into a separate firm.
"When you adopt a ringfence, pressures from inside the organisation tends to weaken the restrictions," Volker said.
"I'm not saying it will be totally ineffective, but the Vickers report says it is going to have a ringfence with exceptions, and once you go down that road of having exceptions the [banking] organisation is going to push for more exceptions and widen the limits," he said.
The warning is likely to be taken seriously by the commission, which is made up of senior MPs and Lords, including the Treasury select committee chairman Andrew Tyrie and former chancellor Lord Lawson.
Tyrie has voiced concerns about the government's proposals to regulate the banking sector and about the powers of the new banking supervisor, which will be an agency of the Bank of England.
The draft bank reform bill put forward by the Treasury is largely based on a report by the Independent Banking Commission, headed by Sir John Vickers. The commission rejected calls to split the banks and hive off their risky operations into separate businesses after furious lobbying by the industry.
Volcker, who is 85 and came to prominence in the Reagan administration as Federal Reserve chairman, is credited with coining the so-called "Volcker rule", which seeks to prevent commercial banks from owning hedge fund-type operations and using their own money to take high risk bets on the markets.
These hedge-fund type services, known as proprietary trading, have generated huge profits and bonuses for executives in boom times, but were in large part responsible for the financial crash of 2008.
Much of Volcker's design for banking regulation has been included in the Dodd Frank Act, which the US Congress passed two years ago and which takes effect next year.
He said the UK had adopted an outmoded view of banking services that categorised services designed to support business customers with the casino activities that brought about the crash.
He also told the commission that the UK had chosen to ringfence the wrong parts of the bank.
"While I would leave lots of services in the core of the bank, I would separate proprietary trading into a separate firm, which can go bust if it gets the risk management wrong," he said.
Tyrie has said his commission will examine the bill for any divergences from the Vickers report, and will consider how its recommendations will shape the incentives and behaviour of banks and bankers.
Tyrie is already concerned about the drafting of the bill.
He said last week: "The draft bill appears to leave a lot of detail to be determined in secondary legislation.
"We will press vigorously to find out what that is going to contain. Only by doing so will anyone – the industry, bank customers, Parliament and the public – be able to find out what this legislation really means for them," he said.
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