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* Free banking stifles innovation and competition -report
* Prospect of paying accounts still unpopular with Britons
* 1 in 2 customers would switch if upfront fees charged
* Nearly two-thirds say not prepared to pay upfront
By Matt Scuffham
LONDON, Feb 2 (Reuters) - British banks' practice ofoffering free current or checking accounts for customers whoremain in credit is unsustainable and increases the risk offuture mis-selling scandals, a report by consultants PwC argued on Monday.
Most major banks in Britain such as Lloyds andBarclays offer free banking alongside paid-for accounts providing perks such as travel and mobile phone insurance.
But the policy remains controversial and some politicians,regulators and bankers have called for it to end, so banks don'ttry to squeeze profits from customers elsewhere. They say endingit would make charges more transparent and improve competitionand levels of service.
Steve Davies, retail banking leader at PwC, said currentaccounts were not as free as they seemed.
"UK current accounts are not free at all and are paid forthrough overdraft charges, penalty fees and uncompetitive orzero rates of interest," said Davies.
"The free banking model stifles innovation and competition,"Davies added, noting it also made it difficult for new entrantswhose presence many see as vital to increase competition.
"It requires new challenger banks to achieve scale veryquickly if they are to survive and it fails to reward banks thatcome up with new ideas as costs cannot be recovered," he said.
The report, based on a survey of over 2,000 people, showed amajority were aware accounts appearing free can carry hiddencharges. However, one in two said they would be likely to changebanks if an upfront fee was introduced instead.
Nearly two-thirds said they were not prepared to payanything up front and 27 percent said they would not pay morethan 10 pounds ($15) a month.
The issue is already being looked at by Britain'scompetition watchdog, which is considering whether banks shouldcharge customers for holding their personal current accounts aspart of a wider inquiry into the industry.
Andrew Bailey, head of the Bank of England's PrudentialRegulation Authority, has called free banking a "dangerousmyth", while some senior bankers also want it to end.
However, the boss of Lloyds, Britain's biggest retail bank,said in November free banking should remain and authoritiesshould not impose charges as part of attempts to shake up themarket. ($1 = 0.6633 pounds) (Editing by David Holmes)
