Since January 2019, banks like HSBC, Lloyds, NatWest and Barclays with deposits of 25 billion pounds ($34 billion) or more have been required to hold extra capital around their retail divisions to insulate them from any blow-ups in separate trading and investment operations.

The so-called ring-fencing regime was introduced after Britain's taxpayers had to bail out several undercapitalised banks during the 2007-09 financial crisis.

"The ring-fencing regime has had no significant impact on competition in retail banking or its submarkets," the review, commissioned by the finance ministry, said in an interim statement.

"The current rules have resulted in unintended consequences that create unnecessary rigidity for customers, banks, and regulators."

Banking lobby UK Finance said last year that Britain should consider dismantling the regime or risk harming post-Brexit competitiveness.

"The ring-fencing regime has the potential to constrain the competitiveness of UK banks, but to date this impact has not been substantial," the review statement said.

UK Finance said it was important to consider whether the benefits of ring-fencing to financial stability outweigh its costs, and it looked forward to the review finalising recommendations for improving outcomes to customers, increasing the regime's flexibility and cutting complexity.

The review, chaired by finance industry veteran Keith Skeoch, signalled in its statement that later this year it would recommend increasing flexibility in the rules to reduce unnecessary complexity, rather than any radical surgery.

The Bank of England's head of banking supervision, Deputy Governor Sam Woods, has vowed to defend the ring-fencing rules to his last drop of blood as banks lobbied for the 25 billion pound threshold to be raised.

Goldman Sachs closed its easy access saving business in 2020 to new customers in Britain after deposits surged close to the 25 billion threshold that would force it to comply with the ring-fencing rules.

Banks have warned that ring-fencing has triggered unfair competition in mortgages as banks inside the ring-fence use deposits to fight for more market share.

The evidence suggests that ring-fencing has not damaged competition in consumer credit, small business lending or mortgages, the review said.

The review said the ring-fencing rules have helped to bolster financial stability, though these benefits have not been observed for smaller and less complex banks which don't have investment banking operations.

Woods has already flagged plans for simpler rules for smaller lenders.

Banks have separate rules on resolution, or procedures for winding themselves up in a crisis without needing taxpayer bailouts, and the review said these rules coupled with ring-fencing added complexity to regulation.

($1 = 0.7350 pounds)

(Reporting by Huw Jones, Editing by Louise Heavens and Angus MacSwan)

By Huw Jones