The European Commission could force Britain's Lloyds Banking Group to sell its Halifax unit as a penalty for a massive state bailout, London's The Times reported yesterday citing unnamed banking sources.

Competition Commissioner Neelie Kroes, who has yet to make a decision on the matter, is planning to impose draconian penalties in Lloyds, according to the report.

"The Commission has not made a final decision, but what they are talking about Lloyds giving up sounds a lot like Halifax," said a person close to the negotiations with Brussels, cited by the daily newspaper.

LBG, which is 43 per cent state-owned after a huge bailout, has slashed thousands of jobs since its creation earlier this year following Lloyds TSB's government-brokered takeover of rival HBOS - which included Halifax.

The paper added that Ms Kroes had rejected LBG's suggestion just to sell its Cheltenham & Gloucester division and various activities in Scotland.

The EC has already forced Germany's Commerzbank to shed 45 per cent of its balance sheet after it received aid from the German state, which now owns 25 per cent of the group.

The Times meanwhile warned that the sale of Halifax would be a major embarrassment for British Prime Minister Gordon Brown - whose Labour government waived competition rules to seal the HBOS rescue.

The forced disposal of Halifax could also spark the resignation of LBG chief executive officer Eric Daniels, it noted.

LBG was created when Lloyds TSB took over HBOS, which faced possible collapse as the credit crunch hitting its ability to raise funds.