* Ill-defined rules give banks more scope to lobby regulator
* Unclear if ring-fenced banks should do more or SME loans
* UK banks' culture shifting away from investment banking
LONDON, Nov 22 (Reuters) - British lawmakers need to define more clearly what banking services they want to ring-fence from risky investment bank activity when they write new rules, Bank of England Governor Mervyn King said on Thursday.
New laws going through Britain's parliament may not protect the public from the cost of another bank crisis if they leave room for banks to renegotiate them with future regulators like the BoE, King told legislators.
"We haven't got to the clarity required," King said to a parliamentary committee looking at the new laws.
"It would be wrong to leave it purely to the discretion of the regulator, because that would increase the pressure of lobbying of banks directly on the regulator and indirectly on the government and parliamentarians," he added.
Britain has stopped short of completely splitting investment bank activities from mainstream banks - something King favours - and instead is working on rules to ensure that banks' day-to-day deposit-taking and lending activities are kept separate from riskier investment banking.
The Bank of England was not responsible for bank regulation during the financial crisis, but from next year it will take over from the Financial Services Authority, assuming the legislation under discussion passes through parliament.
King said parliament was right to start by defining banking services that should be ring-fenced and protected, rather than attempting to list all the investment banking activities that a ring-fenced bank should not carry out, as has been suggested by former U.S. Federal Reserve Chairman Paul Volcker.
However, there is disagreement about where the line is drawn and if, for example, mortgage lending, small business lending, or offering foreign exchange derivative contracts to exporters should be allowed in the ring-fenced part of the bank.
This made it important for the ring-fence to be reviewed several years down the line, King said.
For now, King said he opposed ring-fenced banks offering derivatives, and also said it would be hard to define what counted as a small or medium-sized business for lending purposes. Rather than forcing a business to change bank as it grew, it may be better for it to do most of its banking outside the ring-fenced area, he added.
But Paul Tucker, King's deputy and likely successor when King steps down next June, told lawmakers that it was important small business lending stayed within the part of a bank that would be safest in a crisis.
Tucker also doubted that a full separation of investment banking would improve financial stability more than a partial one, as the collapse of a stand-alone investment bank would still cause major damage.
But bank shareholders' increased reluctance to fund investment banking meant banks' management had a growing incentive to hive off this type of business or conduct it in a less risky fashion, King said.
"I feel that the economics of investment banking is changing - has changed considerably - and that itself is driving the new generation of leadership in banks to recognise that it is in their own interest now to change the culture," he said.