The U.K.'s Independent Commission on Banking has released its interim report recommending that Lloyds (NYSE: LYG) sell off many more of its branches to improve competition in the banking sector. The report urges banks to maintain higher capital reserves and to limit the scope of their retail operations to safeguard the U.K. banking system from riskier operations and further bailouts.

Lloyds, which used a government bailout and a subsequent partial-nationalization, was already being pressed by regulators to slash its assets. Lloyds appointed JPMorgan Chase (NYSE: JPM) and Citigroup (NYSE: C) to oversee the sale of 600 branches. However, if the ICB's proposals are implemented, Lloyds will have to extend its divestments even further, which could mean the sale of 1,000 branches.

The implication
The terms of the suggested divestment are still not very clear, so the financial impact cannot be ascertained. The bank's revenue may be hampered since this is not in sync with the divestiture strategy that Lloyds had planned earlier. Its loan-to-deposit ratio may also increase compared to other banks.

One thing is certain: Implementation of this recommendation will probably rob Lloyds of the huge edge it has in the retail segment. In fact, John Vickers, chairman of the ICB, believes the interim proposals would increase the British bank's cost of capital, which would eventually affect its profits.

The greater situation is similar to that of Ma Bell in the 1980s when the company was forced to split into various smaller parts, including AT&T (NYSE: T) and Verizon (NYSE: VZ), to promote the general health and growth of the U.S. telecom industry. It may not have been the most appetizing strategy for management of the parent at the time, but over the long term the effects on the consumer and the economy in general were positive. (Of course, that breakup has been gradually reversed by reconsolidation, and consumer groups are crying foul at the latest proposed merger between AT&T and T-Mobile.)

The same benefits of divestment could easily be true of Lloyds.

Besides, Lloyds is now considering splitting itself into two and creating a non-core bank with disposable assets kept in a holding bank. The non-core assets would include Lloyds' Australian business and parts of its insurance segment. This will enable the bank to focus more on growth.

The Foolish bottom line
Although the result of this report hasn't surprised many, its repercussions may. Time will reveal the details. In the meantime, stay tuned for a leaner and meaner Lloyds coming to the marketplace.

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Fool contributor Zeeshan Siddique does not own any of the stocks mentioned in the article. The Fool owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.