UPDATE 3-UK Conservatives would scrap financial watchdog

* Opposition plans would see end of FSA, boost BoE powers

* Plans competition review of UK retail bank sector

* Liberal Democrats call for RBS, Lloyds to be broken up

(Adds Myners, Cable comments, background)

By Adrian Croft

LONDON, July 20 (Reuters) - Britain's Financial Services Authority (FSA) regulator should be abolished and the Bank of England put in full charge of supervising financial institutions, opposition Conservatives said on Monday.

The proposals contrast with government plans to entrench the current tripartite system under which responsibility is shared between the FSA, the Bank and the Treasury and risk undermining the regulator with an election due within a year.

The Conservatives, who are tipped to win the election, say the existing system ignored problems that contributed to the credit crunch, forcing the government to spend billions bailing out some of the country's biggest banks.

"We will abolish the Financial Services Authority and the failed tripartite system and give the Bank of England the responsibility for maintaining financial stability and the tools to do it," opposition finance spokesman George Osborne said.

"We will give the Bank responsibility for the prudential regulation of all of our banks, all of our building societies and other significant financial institutions including insurance companies," he added in a speech.

"Crucially this will bring together the operation of monetary policy with the regulation of the banking system."

Finance minister Alistair Darling this month proposed setting up a Council for Financial Stability to coordinate the work of the three groups. The tripartite structure was set up 12 years ago when Labour came to power and when Prime Minister Gordon Brown was the finance minister.

Responsibility for financial market regulation has caused tension between Darling and Bank of England Governor Mervyn King, who has said that the Bank lacked the tools to intervene if a bank ran into trouble.

RETAIL BANK REVIEW

Britain holds large stakes in RBS (RBS.L) and Lloyds Banking Group (LLOY.L), created by the merger of banking groups Lloyds TSB and HBOS, following last year's banking crisis. It also owns Northern Rock bank after a rescue.

Osborne said there should be a review of competition issues in retail banking before any decisions was made on how to dispose of the stakes. He has previously floated the idea of breaking up the banks to avoid creating overly large groups.

"I think it is sensible, given the consolidation that has happened in the retail bank sector over the last 18 months that we ask, through the OFT (Office of Fair Trading), the Competition Commission to do a focused review on that to inform our process of selling the bank shares," he added.

On the broader issue of separating retail and investment banking operations, Osborne said this must be assessed on an international basis.

The smaller opposition Liberal Democrats also put forward proposals on banking regulation, saying RBS and Lloyds should be broken up before they are returned to private ownership.

"The Lloyds-HBOS merger should be unscrambled as part of this process and RBS should also be split with its investment banking operations floated off," the Liberal Democrats' finance spokesman Vince Cable said in a speech at the stock exchange.

Treasury minister Paul Myners defended the tripartite system and said the Bank of England had made clear it did not want to be involved in the day-to-day running of financial institutions.

Osborne would cause "considerable disruption" if he were given the opportunity to implement his plans, he told the BBC.

The FSA defended its work, saying its integrated approach to understanding the business models of financial institutions helped ensure effective supervision and consumer protection.

The British Bankers' Association said regulatory change needed to be "properly and systematically managed".

"We need to take care we do not stifle the financial sector through an effective tax on the size of businesses as scale is important for innovation, lower costs, financial inclusion and international business," it said in a statement. For a factbox on the Conservative proposals, please click on [ID:nLK54215] (Additional reporting by Huw Jones, Kate Kelland and Keith Weir, editing by Mike Peacock/Toby Chopra)