Britain's challenger banks face tax rises as watchdog approves revamp

* Smaller lenders subject to same tax regime as blue-chipbanks

* Challenger banks say tax burden will deter investment

By Sinead Cruise

LONDON, Feb 29 (Reuters) - Fledgling lenders aiming to boostcompetition in Britain's banking industry face sharp rises intheir tax bills after the UK's top competition watchdog endorseda one-size-fits-all approach to taxing the sector.

The Competition and Markets Authority (CMA) said itsinvestigation into the retail banking market found "no strongevidence" that a corporation tax surcharge (CTS) on all banksmaking profit of more than 25 million pounds ($34.6 million)would deter new entrants, stifle growth or force small lendersout of business.

"The six largest retail banks will continue to pay highereffective rates of tax than smaller banks," the CMA said, rejecting concerns of the so-called challenger banks, who claimthat the new system hits them disproportionately.

"The 25 million (pound) threshold for the CTS has resultedin many smaller banks and most mutuals being exempt," the CMAadded.

The new regime replaces an unpopular 0.21 percent levy onbank balance sheets, which was introduced in the wake of the2008 financial crisis and applied to large banks deemed topresent material risk to Britain's economic stability.

Finance Minister George Osborne last year announced plans toreduce the annual levy and introduce an 8 percent surcharge onprofits in response to calls for a revamp in the way Britaintaxes the sector's biggest players, including HSBC,Lloyds Banking Group and Barclays.

News of the CMA's position comes as a blow to recententrants to the market, who say the new system contradicts thegovernment's commitment to giving borrowers greater choice andbroadening the number of capital providers in Britain's economy.

MARKET DOMINANCE

Personal banking and lending to small-to-medium businessesis dominated by Lloyds, RBS, Barclays and HSBC, whichcontrol more than three quarters of personal current accountsand provide nine out of every 10 business loans.

A slew of new and niche banks are bidding to poach marketshare from the blue-chip lenders, including Secure Trust, Virgin Money, Aldermore, Shawbrook, Tesco Bank, Sainsbury Bank, Paragon and Metro Bank.

But Rishi Khosla, CEO and founder of OakNorth Bank, said itis inevitable that the CTS will make it tougher for challengersto compete.

"Any new player considering entering the market, or anyinvestor considering investing in the sector, will be deterredbecause it has suddenly become 8 percent lessattractive," Khosla said.

In submissions to the CMA investigation, one unnamed lendersaid the changes would reduce the investment appeal of new banksrelative to more tax-efficient financial technology start-ups.Another lender warned that product prices might have to rise tooffset the higher tax liabilities and provide the returnsdemanded by investors.

The CMA acknowledged that the full impact of the changes maytake time to emerge and said it would monitor how smallerlenders cope with the new tax regime.

"In our opinion, this is the wrong way round. The CMA hasrecognised that it could have an impact and that smaller bankswould be most affected, so it should address this proactivelyand get on the front foot before it has a detrimental impact,"OakNorth's Khosla said.($1 = 0.7217 pounds)

(Editing by David Goodman)