Andreas Whittam Smith: The dealing room had it coming

It is a no-brainer for me. Undoubtedly the bankers themselves – that is, the boys and girls in the dealing rooms and their elders in the boardrooms – were responsible, "jointly and severally" as a lawyer would put it, for the financial crisis with which we struggle still. One estimate suggests that the consequence has been the loss of some 16 million jobs around the world. That is why I support the introduction of a special levy on banks.

If you cause a lot of damage, you must expect a heavy reckoning. George Osborne, the new Chancellor of the Exchequer, said in his speech at the Mansion House in the City of London on Wednesday night that it was an issue of fairness. It is indeed. The levy should be on a sufficient scale to make other tax increases less onerous and preserve some public services that might otherwise have been cut.

There have been attempts to spread the blame more widely. Didn't we consumers become addicted to debt? Surely the credit rating agencies shouldn't have allowed themselves to be suborned by financial institutions into providing unduly favourable assessments? Weren't the non-executive directors of the banks together with their shareholders, their accountants and their auditors asleep at the switch? And where were the regulators when all this was going on?

These important questions require answers and, if necessary, remedies. But they don't get to the heart of the matter, the nature of modern banking. The key feature is that because some banking activities – such as accepting deposits, providing credit and facilitating payments – are so essential to economic activity that it can be assumed that governments will always provide support if any weakness develops. This guarantee is not written down anywhere. And from the banks' point of view, because it is undocumented, it is costless.

Banks aren't any longer, however, simple businesses solely carrying out the activities described above. They have become huge organisations that engage in scores of different activities, often inter-connected, with some being more suitable for gamblers than for sober citizens. In practice, therefore, the government guarantee extends far further than the core tasks.

There are further consequences. The banks have taken this implicit arrangement as a green light for expanding their businesses by themselves borrowing on a substantial scale. You can find British banks that have borrowed £70 for every £1 of invested equity. In certain investment banking activities, the ratio can rise to £200 to £1. Providing everything turns out as expected, this gearing multiplies profits many times over and with it the remuneration of staff. Bankers have therefore been given a strong incentive for reckless behaviour.

What is to be done? The Future of Banking Commission set up by Which? that has just reported, correctly observed that, "Britain cannot leave the taxpayer open to an unlimited assault on the public purse. The best option is to make the guarantee explicit and tightly circumscribed". And this seems to be the route along which Mr Osborne wishes to travel. He is setting up an independent commission on the banking industry. Notice that this commission has not been asked to examine regulation but rather the structure of banking, the state of competition in the industry and how customers and taxpayers can be sure of the best deal.

The Chancellor also referred to just one possible structural change out of many – the separation of core banking from the rest so that shareholders in Barclays, for instance, would end up owning two legally separate banking companies, the one doing utility banking, the other doing the rest. The guarantee would be explicitly extended to the first entity but not to the second.

Mr Osborne noted that some of the most fervent believers in free markets are the most ardent proponents of structural separation, "including the man who more than almost anyone else created the modern City of London", his Conservative predecessor, Nigel Lawson. This is a strong hint of what Mr Osborne thinks the answer should be.

How the banks would hate this solution. They have thought up five reasons why it would be impractical. First, it would require hard-to-achieve global agreement. But if we moved first, probably other countries would follow. The White House is also considering the idea. Second, the sophisticated financial needs of the global economy, we are told, can only be delivered off a "broad trading and banking platform", whatever that may mean. This is perhaps a way of saying that one-stop banking would serve business-users better than a series of independent specialist providers. But modern business is very comfortable in handling multiple suppliers.

The third objection is that failing non-utility banks cannot be left to market forces to sort out. Lehman Brothers was not a deposit-taking institution, for instance. But the problem with Lehman Brothers was that everybody assumed it enjoyed the implicit guarantee until the Federal Reserve Bank decided it didn't. Chaos indeed followed. But under the structural reform proposals, there would be no ambiguity. It would be shouted from the rooftops that certain types of banking activity had no government guarantee and customers would deal with them in the light of that knowledge.

The objectors also allege that banks specialising in a narrow range of activities are risky too. Yes, but only to the extent that all business undertakings are risky. In any case, good regulation could provide mitigation. Finally the argument is made that the financial crisis was caused by excessive leverage and inadequate capital, not the sheer scale of banks' activities, and can be addressed by less radical solutions than breaking them up. But this interpretation leaves out of the account the way the implicit guarantee perversely drives reckless trading.

In fact I think the greatest difficulty with the proposal lies elsewhere. It is the problem of knowing where exactly to draw the line between the activities of utility banks and the rest. I notice that the Future of Banking Commission divides banks into four categories rather than two – retail, commercial (or wholesale), investment and trading (really dealing). In other words, the answer may be to replace today's monolithic banks with a multiplicity of specialist units. The merits of such an outcome are not exactly a no-brainer, but the notion has strong plausibility.

a.whittamsmith@independent.co.uk