It proposes to ring-fence retail and investment banking to protect consumers from heavy investment banking losses.

It also proposes that banks should have higher capital and equity requirements than the current seven per cent requirement of Basel III.

Smaller banks with less than £25bn in deposits will be exempt from the ring-fencing requirements to increase competition in the banking sector.

Speaking to Parliament, Mark Hoban, Financial Secretary to the Treasury, said: “Our proposals are ambitious but balanced in impact. They promote financial stability while supporting sustainable growth and the role of the UK as the world’s leading international financial centre.

“First, since future financial crises rarely repeat the pattern of the past, we must make banks more resilient to shocks. Second, we must make our banks more resolvable so that, if they fail, they don’t threaten the provision of vital services to the real economy.

“Seeing through these two goals will achieve our third - to curb risk taking in financial markets. It must be clear that investors reap rewards when banks do well, but take the pain if banks fail.”

Dr Vince Cable, secretary of state for business, innovation and skills, said: “This Government is delivering a major piece of reform. We are leading the world in establishing the principle that investment banks should be separated from traditional banking, as part of a regulatory system in which the public do not subsidise banks and banks are not allowed to fail without a threat to the system at large.”

Draft legislation on the proposals will be issued in the autumn and all legislation will be completed by the end of this Parliament in 2015. Banks must comply with the proposed measures by 2019.

The paper is open for consultation until 6 September.