David Prosser: The time when Britain's banks are no longer too big to fail is almost upon us

Outlook Four words have haunted us since the earliest days of the financial crisis four years ago: too big to fail. But if thedowngrades of British banks' credit ratings announced yesterday by Fitch areanything to go by, we may finally be laying the ghost to rest.

In most circumstances, credit rating downgrades are bad news – George Osborne works night and day to prevent the same fate befalling UK sovereign debt – but the Fitch cloud has a very shiny silver lining. Like Moody's last week, Fitch has cut its ratings for Lloyds and Royal Bank of Scotland for one reason only: it no longer assumes that the UK Government would have no choice but to step in in the event of their insolvency. These banks, in other words, may no longer be too big to fail.

The game changer has been the Independent Commission on Banking's proposal that the retail operations of our biggest banks must be ring-fenced from other more risky areas of the business. No longer will the Government have to intervene to protect retail customers in the event that a bank is plunged into difficulties by its investment banking arm.

The ICB's determination to stick to its guns on ring-fencing despite the opposition of the banks – though note that now it is a fait accompli, they no longer seem quite so worried – is to its great credit. On its own, however, ring-fencing will not completely solve the too-big-to-fail problem. Lehman Brothers had no retail arm that needed a ring-fence yet its collapse was systemically disastrous.

The missing bit of the jigsaw is the final detail of a resolution regime, an agreed procedure for dealing with the failure of a bank in an orderly fashion. We are close to part of that, with British banks expected to draw up "living wills" by the end of the year (European banks, typically, will take a year longer), agreeing plans with regulators about the way they would be dismantled if needs be. But the argument continues over the idea that regulators should be allowed to force a failing bank's bondholders to swap their debt for equity.

That arrangement, "bail-in" in the jargon, has much going for it since it falls short of a full-scale insolvency procedure. But it will require a bank'ssenior creditors to accept the possibility of incurring losses – and while that sounds perfectly reasonable it may mean an increase in the cost of borrowing for banks. It may also prevent certain types of investors – pension funds with especially cautious investment mandates, for example – from buying bank debt.

The discussions around bail-in will continue for some time yet, not least because to adopt the idea in some countries would require amendments to existing insolvency legislation. Still, amid the fear of the banking crisis that the eurozone's sovereign debt crisis may yet prompt, we can at least take some comfort from the progress that has been made on too big to fail. In that sense, the news from Fitch is very positive.