The Treasury has announced a major shake-up of the UK banking sector.

Lloyds Banking Group and RBS are set to sell off parts of their businesses in order to meet European Commission competition requirements, published later today.

Both banks are changing their commitments to the government’s Asset Protection Scheme (APS).

Lloyds will not participate in the APS and instead will raise additional private sector capital and pay a fee to the taxpayer for the implicit protection provided so far. The government says this will reduce the risk borne by the taxpayer, improving value for money.

Lloyds has announced plans to raise £21 billion through a combination of a £13.5 billion rights issue, and £7.5 billion by swapping existing debt for contingent capital.

Lloyds will also pay the government a fee of £2.5 billion in return for the implicit protection already provided by the taxpayer since the announcement earlier in the year. The government will take up its rights as a shareholder in Lloyds to participate in the planned capital raising, investing £5.7 billion net of an underwriting fee.

This will see the government’s shareholding in Lloyds remain at 43%.

Lloyds has indicated it will sell 600 of its retail branches such as Lloyds TSB Scotland and its Cheltenham & Gloucester mortgage business branches, as well as selling the Intelligent Finance and TSB brands.

RBS will continue to participate in the APS under revised terms which will see the taxpayer’s stake in the bank rising from 70% to 84%.

Both banks will still be required to meet tough conditions on pay and lending, the Treasury insists. This includes a commitment not to pay discretionary cash bonuses in relation to 2009 performance to any staff earning above £39,000. In addition executive members of both boards have agreed to defer all bonuses payments due for 2009 until 2012, to ensure that their remuneration is better aligned with the long-term performance of their banks.

In return for taxpayer support provided, both banks have agreed that existing commitments to increase lending to businesses and homeowners by a total of £39 billion for both banks will remain in place.