Hamish McRae: Taxpayers should not have to bankroll another meltdown

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Banking will, in another decade, be different.

But just how different will be determined in the US, Continental Europe and China, as much as in the UK. The only way to see the new British proposals for banking reform is to put them in an international context. It is a global industry with the most highly valued banks, with just one exception, having their headquarters elsewhere.

That exception is HSBC, whose initials tell a tale in themselves. They stand for Hong Kong and Shanghai Banking Corporation, and its chief executive is based in Hong Kong because its main growth prospects are in Asia. The other British-based bank with major global ambitions is Barclays and it is as much a global investment bank as a UK commercial one.

However Britain does matter hugely as an international banking centre, for more international banking business is conducted through London than any other place in the world. Banking is Britain's largest export industry. But there is a Wimbledon effect: the City provides the grass on which competitors from other countries come to play.

Banking regulation must change here and elsewhere. It is intolerable for taxpayers to have to carry the risks of another global banking meltdown. There are two key issues here. Should commercial and investment banking be split? And how should countries resolve the "too big to fail" conundrum? On the first, the argument for a split is that the two types of banking are very different. To simplify, commercial banking is the straightforward business of taking deposits over the counter, on the internet or on the money markets, and lending these deposits to businesses and individuals. Investment banking is partly raising funds for business on the stock exchange and dealing with their other more complicated financial needs. But it is also trading in foreign exchange and other investments, sometimes very complex ones, on the bank's own account.

The general perception is that the former is less risky and needs less of a cushion of capital than the "casino banking" of the latter. That is largely right, though banks can lose huge amounts on things like property loans if prices fall. The collapse of HBOS was largely the result of poor lending, not trading in complex products.

So the question is whether banks should be forced to split or whether you should allow banks to carry out both functions, but apply different levels of capital requirement to each function.

There is as yet no international agreement. But clearly there cannot be a state of affairs where taxpayers give a guarantee, explicit or implicit, that allows banks to take risky bets on complex financial markets. Nor do you want regulatory arbitrage, where banks shop around the world to find the most lenient place to do business.

The "too big to fail" issue is if anything even tougher. The enterprise that triggered the first run on a bank in Britain for more than a century, Northern Rock, was tiny by world standards. So in practice just about any bank is too big to be allowed to fail. Besides really big banks, such as HSBC, have a global footprint that makes them more stable than small ones heavily dependent on a single market, such as British home loans. Somehow governments have to make it clear that while deposits are guaranteed, all other transactions are not. And they have to agree internationally, at least on the broad principles, if not on the detail. Not easy, but it has to be done.