An independent Scotland would have a vastly oversized financial sector that would leave it vulnerable to a Cyprus-style banking crisis, Britain's finance ministry says.
Before a referendum due in September 2014 on whether Scotland should split from the United Kingdom, the British government is analyzing the impact of independence on Scotland, which has a population of about 5 million.
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A report from the finance ministry - or Treasury - says that without the British government's regulatory framework, Scotland would be left vulnerable by having a banking sector that dwarfs its economy, driving businesses out of the country.
"An independent Scotland would have an exceptionally large banking sector compared to the size of its economy - with banking assets of more than 1250 percent of Scottish GDP - making it more vulnerable to financial shocks and the volatility of the sector," said a Treasury statement which contained excerpts from the report, due to be published on Monday.
The Scottish National Party (SNP), which controls Scotland's devolved government and is behind the independence campaign, dismissed the report and said it would produce its own study on Tuesday highlighting the benefits of a split from Britain
"An independent Scotland will be an economic success story, as we will outline this coming week, and the tall tales from the Treasury can't hide that reality," said Scottish Finance Secretary John Swinney of the SNP.
Opinion polls indicate the pro-independence movement in Scotland has the support of about a third of voters, while nearly 60 percent want to stay in the United Kingdom. British Prime Minister David Cameron has campaigned against Scottish independence.
At 12-1/2 times the size of Scotland's economic output, Scotland's banking sector would be even more out of proportion to the economy than that of Cyprus, which ground to a standstill earlier this year as the cost of recapitalizing its banks, which had assets worth nine times its GDP, spiraled.
"Overall, the experience of financial crises shows that countries with a large banking sector compared to the size of their GDP are significantly more vulnerable," the Treasury statement said.
Scotland currently benefits from the British government's capacity to support struggling banks.
During the 2007/08 financial crisis, government support for Britain's financial sector peaked at more than 1 trillion pounds' ($1.5 trillion) worth of guarantees and cash injections.
The Treasury report will say any future bank rescues would place a heavy burden on Scottish taxpayers, and could generate concerns about state finances that might discourage firms from basing their operations there.
Previous reports from the British government have said that there is no clear case for an independent Scotland to share use of the British pound, and that it might have to reapply for membership of international bodies such as the European Union.
(Editing by Pravin Char)