Director for financial stability Andrew Haldane says current initiatives are step in right direction but do not go far enough

The Bank of England has warned that a full breakup of Britain's banks might ultimately be needed to prevent their problems wrecking the economy or burdening the taxpayer.

Andrew Haldane, Threadneedle Street's director for financial stability, expressed doubts that current proposals would be sufficient to tackle the "too big to fail" issue that has dogged the financial sector since the crisis of 2007-08.

In a speech to the Institute of Economic Affairs on Thursday night, Haldane said current initiatives were a step in the right direction but did not go far enough.

Ultimately, he said, banks might need to have their activities curtailed by tough capital requirements, limits on their size or a modern Glass-Steagall Act, the 1930s law that separated investment from retail banking in the US.

Haldane said banks had increased in size dramatically over past decades and this – together with consolidation and concentration of the industry – had created expectations of state bailouts in times of trouble.

"These expectations generate lower funding costs, in particular for the largest banks, which in turn encourages further expansion and concentration, worsening the too-big-to-fail dilemma," Haldane said.

In 2009, following the government support that followed the collapse of Lehman Brothers, Haldane said estimates of the implicit taxpayer subsidy to the world's banks came to $700bn (£435bn). This implied that "too big to fail had become hardwired into the structure and pricing of the financial system".

Subsequent reforms of the banks have involved forcing them to hold more capital so that they can absorb losses, ensuring that mechanisms are in place to wind them up without bringing down other institutions with them – so-called living wills – and proposals to prevent the speculative activities of banks damaging their high street operations.

Haldane said the extra capital surcharges agreed internationally would leave much of the implicit taxpayer subsidy intact. He flagged two possible problems with more effective wind-up regimes: that they would lead to even greater concentration of banks and that there was a risk governments would take the safe option of a bailout if a big bank ran into trouble, rather than face the threat of a systemic meltdown.

Haldane said that was concerning, because there was already evidence that recent bailouts had increased government debt to levels that "may be a significant drag on medium-term growth".

Since the crisis, teams of experts led by Sir John Vickers in the UK, Paul Volcker in the US and Erkki Liikanen in the EU, have been looking at ways of separating investment and retail banking.

In order to prevent cross-contamination, Haldane said "full and faithful implementation of the spirit as well as the letter of the Volcker, Vickers and Liikanen plans" will be needed.

A true separation of capital and culture within the big banks, together with the elimination of "too big to fail" would "require entirely separate governance, risk and balance sheet management on either side of the ringfence … Only time will tell whether cultural separation can be achieved under the existing structural reform proposals."

Noting that current reform proposals may prove insufficient, Haldane outlined a number of more radical suggestions. Increasing the level of capital that banks have to hold to several times the current suggested levels would "reduce materially expected system-wide losses".

In addition, limits could be put on the size of banks, since despite claims by the industry that bigger institutions were more efficient and less costly to operate, there was no evidence that economies of scale applied to banks above $100bn.

Haldane said a full separation of investment and commercial banking – "a modern-day Glass-Steagall Act" – would lessen the risk of basic banking activities being starved of human or financial capital. Increasing competition by removing the barriers to entry would also help to reduce banking concentration and with it the "too big to fail" problem.