* Banks call for level capital playing field for newcomers
* Newcomers should have cheaper access to payments system
* Local authorities should place deposits with new banks
* Regulation should be proportionate to size of bank
By Matt Scuffham
LONDON, June 23 (Reuters) - Britain should relax rules for new banks to enable them to compete on a level footing with established lenders and stimulate competition in the industry, the country's banking lobby group said on Monday.
The British Bankers' Association (BBA) wants capital requirements for new banks to be less onerous and levels of regulation more proportionate to the size of the institution. It also recommended the industry's payments system be cheaper to access by new banks and that local authorities and government departments be encouraged to place deposits with them.
Banking reform is high on the agenda of Britain's political parties in the run-up to the 2015 election and many lawmakers say a lack of competition contributed to some of the scandals that have hit banks in recent years and fanned public anger.
They include the mis-selling of loan insurance, Britain's most expensive consumer scandal, which has so far cost banks more than 20 billion pounds ($34 billion) in compensation.
Opposition Labour leader Ed Miliband has said he will consider limiting the market share of big banks should his party come to power.
The government last year gave Britain's Prudential Regulation Authority, which monitors the safety and soundness of banks, a secondary objective to stimulate competition within the industry, while Britain's new competition watchdog is considering investigating the industry. [ID::nL6N0M83HX]
Lawmakers are keen for new banks to break the dominance of Britain's "Big Five" of Lloyds, HSBC, Royal Bank of Scotland, Barclays and Santander UK which account for more than three-quarters of lending.
The BBA's director of strategy, James Barty, said ministers and regulators should implement plans to support competition within banking and encourage new banks to set up and grow.
"The best way to promote competition is by creating a more level playing field for players of all shapes and size. It's vital that we don't treat all banking markets as the same and introduce rules, regulations and costs that smother changes that are already driving competition," he said on Monday.
Britain's regulator unveiled sweeping changes last year and is expected to add more elements over the next year to help reduce barriers to entry. It has reduced the amount of time it takes an applicant to be granted a bank licence to within six months from a year or more previously. About 20 applications are currently being assessed.
The regulator has also said capital requirements will be lighter for the first three to five years as long as a new bank can show deposits are insured and they are set up with full recovery and resolution plans set out in case they hit trouble.
Metro Bank became the first new high street lender to emerge for over 100 years when it was granted a bank licence in 2010.
TSB, which was last week spun off from Lloyds, has emerged as a credible challenger with 4.5 million customers, while Virgin Money, owned by British entrepreneur Richard Branson and U.S. billionaire Wilbur Ross is expanding and will offer personal current accounts later this year.
Retailer Tesco's banking arm has also launched current accounts while other new challengers, such as Aldermore and Shawbrook, have also opened for business, focused on small business lending.
Barty said challenger banks still have to put up more capital on the same type of loans than the biggest high street lenders do. Big banks have an advantage because they use internal models which reduce the capital they need to set aside for loans based on their past history. New banks have to treat all loans in the same way, meaning they have to hold more capital against less risky lending such as low loan-to-value and low loan-to-income mortgages than their larger rivals.
"What it basically forces the challengers to do is go up the risk curve. If you want to have a level playing field for challengers you need to do something in that area," he said.
$1 = 0.5880 British Pounds Additional reporting by Steve Slater; Editing by Pravin Char