The heavy hand may not descend, but any semblance of a light touch in U.K. banking regulation will soon disappear. That is the clear verdict -- cloaked in the usual bureaucratic prose -- of the U.K. Treasury's new white paper, published on July 8.

"There is a massive, dramatic shift taking place in the regulatory framework," says Benedict James, a banking regulatory partner at Linklaters LLP. "It seems likely the banks will pay a heavy regulatory price for the recent massive government support for the industry."

Though criticized for ducking important issues, providing little detail and betraying a rather leisurely approach to the overhaul of a banking system that has just endured the most profound crisis since the Great Depression, the proposals take clear aim at Britain's banks. They call for higher capital and liquidity requirements and propose a much wider scope for the Financial Services Authority to act.

A clash between the government and the industry seems inevitable. As James points out, "The government is not running scared of the City as it used to."

What's more, the opposition Conservative Party vows to take a more radical approach. The polls overwhelmingly favor the Conservatives to win the next general election, which must be called no later than May 2010.

The Treasury's white paper is in large measure a green [discussion] paper. The Treasury's emollient approach, one that is characteristic of its head, Chancellor of the Exchequer Alistair Darling, initially won the cautious approval of the British Bankers Association's chief executive, Angela Knight. "Banks recognize the need for change," she said in an early statement.

She was perhaps diverted by the power struggle between the Bank of England and the Financial Services Authority and the establishment of a new Council for Financial Stability.

Later Knight realized, as her blog reveals, that the paper presages tough new capital and liquidity requirements. The Treasury's paper said that the "level and quality of capital were calibrated too low to ensure the financial system could absorb losses of the scale seen." The FSA will be charged with determining the new levels and which "systemically significant" banks will be subject to particular scrutiny.

Talk of higher capital requirements has already sparked resistance from the British Bankers Association.

As a spokeswoman for the BBA says, "We don't agree that banks need to raise their capital levels. The U.K. could be put at a competitive disadvantage if there is no international cooperation on increasing capital requirements." In any case, "U.K. banks have significantly increased their capital levels in recent months," she adds.

The paper presents other potential regulatory threats, most notably an increase in the FSA's power to act pre-emptively to prevent instability, but these are modest in comparison to some of the sweeping ideas being discussed by the Conservatives.

George Osborne, the shadow chancellor of the Exchequer, has signaled that not only is he willing to effectively abolish the FSA and hand over its powers to the Bank of England, but, more importantly, he is looking at restricting the size of banks. "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," said Osborne in April.

This aligns Osborne with Mervyn King, the governor of the Bank of England, who has seemed to favor a U.K. version of the Glass-Steagall Act of 1933. Last month, he said that banks that were too big to fail were simply too big.

By contrast, the Labour government has firmly dismissed that idea. The white paper argued that "there is little evidence" that "artificial restrictions on a financial institution's size or complexity would automatically reduce the likelihood of firm failure."

The BBA also rejected King's position. Said a spokeswoman, "We believe there is no need for a U.K. version of Glass-Steagall."

But some of the U.K.'s banks have been slow to grasp just how dramatically the economic environment has changed. Knight wrote on her blog on July 13 that "Britain seldom builds a world class industry, yet in banking and financial services it has done just that." Left unmentioned in Knight's blog post are the hundreds of billions of pounds poured into the sector by the government since October.