Leader: Ring-fencing banks' risky business is not enough

CHANCELLOR George Osborne's Mansion House speech last night may have struggled to convey a convincing recovery story for the British economy. But it sent two clear signals intended to show progress on the long, painful process of bank recovery after the worst financial crisis in 90 years.

First, he gave a clear nod of support to the Independent Banking Commission over its interim proposal to ring-fence the retail operations of universal banks from their "casino" or investment banking activities. And he signalled that Northern Rock - the first bank to buckle as the crisis deepened in the autumn of 2007 is to be sold back to the private sector. The auction is expected to raise 1 billion, with the government still retaining the "bad bank" toxic loans.

These are welcome signs of progress, slow though they have been in coming, and announced just when anxieties over the financial state of Greece have taken a sharp turn for the worse. The sovereign debt crisis that has blighted the eurozone flows directly from the financial crisis and the recession which followed. Progress is one thing. Sustained recovery is quite another.

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On the banks, the Chancellor made a telling point. The banking sector has had to de-leverage dramatically. But the economy still grew by 2.5 per cent as the financial sector shrank by 4 per cent - a rate of growth above its average of the past two decades. However, that growth has been slowing of late and much still remains to be done, both to sweat down the toxic assets of the "bad" banks and to create a new regulatory regime that will help ensure that the bubbleonia of 2003-7 will not be repeated.

Ring-fencing the investment banking operations falls far short of the complete separation that many have urged over the past two years. And many questions are still to be resolved over how this system of ring- fencing will work. Stephen Hester, chief executive of the 84 per cent taxpayer-owned RBS, has been a critic of these proposals. Public assessment, however, cannot be complete until the Deloitte report on why RBS suffered a near total collapse is published. As the analysis also assesses the role of the Financial Services Authority, publication delay by the FSA has been little short of scandalous.

As for the proposed regime, an immediate concern centres on the cost to bank customers by way of lower deposit rates and/or higher charges as a result of the regime. Details will be keenly awaited as to how it will exactly it will work. But the banks could hardly expect a return to the ancien rgime, and ring-fencing is still a major reform in its own right.

And there are other important elements. A higher reserve ratio against banks' risky assets, and heightened supervision by new regulatory agencies under the Bank of England will also be of critical to ensure there is no repeat of the debacle.