UPDATE 2-UK's Cable attacks banks for trying to slow reform

* Key banking commission report due on Sept. 12

* ICB expected to back earlier ring-fencing proposal

* Barclays expects "pragmatic" proposals from ICB report (Adds comments from Barclays and sector analyst)

By Keith Weir and Sudip Kar-Gupta

LONDON, Aug 31 (Reuters) - British Business Secretary Vince Cable accused the country's banks of using the euro zone crisis to resist industry reforms, as a government-appointed commission finalises plans to restructure the sector.

Business and industry groups have argued that a weak domestic economy and turmoil in the euro zone mean that banks, a powerful lobby group because of the importance of London's financial district to the UK economy, should not be burdened with extra regulation.

Britain's "Big Four" banks, Barclays , HSBC and part-nationalised lenders Lloyds and Royal Bank of Scotland , have stepped up their lobbying ahead of the Independent Commission on Banking's (ICB) final report on Sept. 12.

The ICB is expected to back proposals made in an interim report, when it said UK banks should ring-fence their retail operations from riskier investment banking operations to protect taxpayers from future crises.

"It is disingenuous in the extreme to use the current context to argue against reform. Banks are in a way trying to create a panic around something which they know has got to happen," Cable told The Times newspaper.

Cable, a former economist and a member of the Liberal Democrats, the junior party in the coalition government, has long argued for a tough line to be taken with banks.

Finance minister George Osborne, of the larger Conservative Party in the coalition, backs the ring-fence but could allow banks until 2019 to implement the plans, a timetable the Lib Dems believe is too long.

ICB HAS AVOIDED FULL SPLIT OF BANKS

Britain wants to avoid a repeat of the financial crisis of 2008-09, when the state spent billions of pounds to avert the collapse of Royal Bank of Scotland and HBOS, now part of Lloyds .

The state owns 83 percent of RBS and 41 percent of Lloyds.

Barclays shares were up 1 percent in late morning trade, with HSBC up 0.8 percent, Lloyds up 0.7 percent and RBS flat.

British Prime Minister David Cameron said on Wednesday that he would wait for the Sept. 12 report before saying more about the industry, but set out two key requirements.

"First of all, to be lending into the real economy so we can support growth and jobs," he told Sky News.

"And the second thing, we do need to make sure that our banks aren't taking risks that put the economy at risk," he added.

The ICB's April interim report suggested setting up the ring-fence while preserving the structure of a holding company looking after both the retail and investment bank arms.

This is designed to ensure that a bank's core retail and business lending activities continue to function if a trading arm fails.

However, Cable said he did not think the ICB's likely proposals would efficiently tackle the problem of how to allow big banks to fail "safely" and avoid the problems that arose in 2008, when Wall Street bank Lehman Brothers collapsed, causing mayhem in the world's financial markets.

"The Governor of the Bank of England and many other people have been arguing that we have to deal with the too-big-to-fail problem," Cable added.

"We can't have big global banks with balance sheets bigger than British GDP underwritten by the taxpayer: this can't go on, and it has got to be dealt with," Cable added.

The banks themselves have also attacked the ICB's proposed reforms.

The ICB is expected to ask banks to hold more capital and has targeted a core Tier 1 Capital ratio of 10 percent, but the banks say this could put them at a disadvantage to American and Asian rivals and could restrain their lending activities.

On Wednesday, Barclays reiterated its opposition to the ring-fencing idea but said it was confident it could manage any new rules suggested by the ICB.

"Whilst we recognise the need for a safer financial system, ring-fencing is not our first choice, but we are confident that a pragmatic set of workable requirements will emerge which we will be able to manage," Finance Director Chris Lucas told an investor conference organised by Nomura.

The big issue to be clarified in the report is how far the ICB, led by John Vickers, will go with its proposals for ring-fencing retail banking.

The ICB wants to protect core retail banking businesses, such as deposits and cash management, but take away an implicit guarantee for riskier investment banking and other capital markets activity.

Investors are concerned the commission will define a strict ring-fence, limiting use of customer deposits to finance investment banking operations, thus increasing funding costs and triggering credit ratings downgrades.

JP Morgan Cazenove and Seymour Pierce said in research notes this week that Barclays and RBS would be most at risk of reduced earnings as a result of the ICB's findings. (Reporting by Keith Weir; Editing by Greg Mahlich and Will Waterman)