UPDATE 1-Business leaders cast doubt on Scotland using the pound informally

Wed Feb 26, 2014 5:51pm EST

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By Huw Jones and Belinda Goldsmith

LONDON Feb 26 (Reuters) - An independent Scotland's use of the British pound without the permission of the rest of the UK could endanger the stability of the nation's financial sector, Scotland's financial services industry head warned on Wednesday.

Owen Kelly, chief executive of the Scottish Financial Enterprise, said adopting sterling informally would mean losing the services of the Bank of England as a backstop and having to shoulder the cost of setting up a new Scottish regulator.

He said using sterling outside its jurisdiction would create uncertainty for the large financial sector in Scotland, home to a quarter of the UK's life insurance and pensions industry.

"It would be hard to imagine the industry as it currently exists and it would have to reconfigure to that new economic environment," Kelly told the British parliament's Scottish Affairs Select Committee.

"It's an open question whether you could continue to serve UK customers from another jurisdiction."

His comments come as a currency row has inflamed the debate over Scottish independence in recent weeks.

Scottish leader Alex Salmond wants to keep the British currency in a monetary union with the rest of the UK and retain the Bank of England as lender of last resort, running monetary policy and setting interest rates.

But the main parties in Westminster have joined forces to flatly reject this as an option.

Refusing to give an alternative plan, Salmond has insisted that Scotland would continue to use the pound, accusing the UK parties of bluff and saying a currency union was clearly in the interests of both countries which are key trading partners.

"PANAMA PLAN"

His critics have branded any unilateral use of sterling as the "Panama Plan", alluding to Panama's adoption of the dollar without U.S. involvement.

Kelly said using the pound unilaterally, or "sterlingisation", could prompt ratings agencies to downgrade Scottish debt as the country would not be in charge of its own monetary policy and would need huge reserves of sterling.

Senior financial policy officials also told lawmakers how an independent Scotland would need to carefully organize its financial sector if Scots voted on Sept. 18 to end a 307-year tie with England.

Andrew Bailey, deputy governor of the Bank of England and head of its regulatory arm, the Prudential Regulation Authority (PRA), cast doubt on a Scottish proposal to share a prudential regulator with the rest of the UK if both countries had sovereign parliaments.

"It is not a system I observe operating in any other part of the world that has a major financial system. It would require very careful thought about how the single regulator would go about managing that," Bailey told the committee.

He also voiced concerns over the difficulty of a currency union, saying this would need strong institutional support.

Mark Neale, chief executive of the UK Financial Services Compensation Scheme, responsible for ensuring deposit holders' money is safe, said under EU law an independent Scotland would need its own scheme to protect depositors at Scottish-based banks.

He said the Scottish government would have to be ready to step in with funds if the Scottish financial sector could not shore up a collapsed Scottish bank.

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