By Kirstin Ridley

LONDON, Feb 17 (Reuters) – A quest by British regulators to protect local taxpayers by pruning the branches of global banks is riling the industry and risks running roughshod over a principle of free movement within Europe.

Britain’s Financial Services Authority (FSA), which unilaterally published tough new liquidity rules for banks last year, is keen to stop banks operating in London from setting up branches. It prefers subsidiaries, which are easier to police.

This push for “subsidiarisation” has gathered steam since the collapse of Icelandic banks in 2008 left UK depositors empty-handed, shattering a European principle that national regulators will protect the interests of international clients.

While bankers have dubbed this drive “simplistic” and “troubling”, lawyers note the FSA needs to leapfrog a so-called passporting rule, under which banks are allowed to set up branches across the 33-nation European Economic Area (EEA).

“One … has to question whether there would, in fact, be sufficient appetite to agree such a change among the smaller (EU) member states, who could see a risk of being shut out of the major European financial markets,” notes Ben Kingsley, a partner at London law firm Slaughter and May.