UPDATE 1-UK watchdog tells banks to open up payment system to competition

(Adds detail, VocaLink ownership)

By Huw Jones

LONDON, Feb 25 (Reuters) - Banks should cut their stakes inone of Britain's core payments systems as part of a fundamentalchange to increase competition, Britain's Payment SystemsRegulator (PSR) proposed on Thursday.

The UK payments network is a patchwork of infrastructurebuilt over many years and the PSR was set up after lawmakerscalled on the government for changes after customers suffered astring of glitches.

The PSR said the VocaLink system, which processes more than90 percent of salaries, over 70 percent of household bills andalmost all state benefits, is owned and controlled by arelatively small number of lenders.

"The evidence published today indicates that the commonownership of this infrastructure provider by this small numberof banks is having a negative effect on innovation andcompetition in the industry," the PSR said in a statement.

"As a result, the PSR is proposing that these banks sellpart of their stakes in VocaLink in order to open the market andallow for more effective competition and innovation."

VocaLink, owned by a consortium of 18 banks and buildingsocieties including Barclays, RBS, Lloyds, HSBC and Santander, processed morethan 11 billion transactions worth 6 trillion pounds ($8.4trillion) last year.

The PSR will consult on the proposals until April 21.

The regulator said the way operators procure paymentinfrastructure prevents other potential providers from enteringthe market.

It proposed a competitive and transparent procurementprocess that will be independently monitored. The regulator alsoproposed a common electronic messaging standard to make iteasier for new entrants.

"There needs to be a fundamental change in the industry toencourage new entrants to compete on service, price andinnovation in an open and transparent way," PSR ManagingDirector Hannah Nixon said.

The proposals could create opportunities for new types ofpayments companies from the so-called "fin tech" sector, Nixonsaid.($1 = 0.7171 pounds) (Editing by David Holmes)