Break up RBS,Barclays while there’s still time

In the last week,the UK banking industry has given a vivid illustration of its ability to bounce back from calamity. All the main deposit-takers reported results that were surprisingly good,given the depth of the credit crisis. Lloyds Banking,the UK’s largest mortgage lender,reported its first profit since the purchase of HBOS forced Lloyds to seek a government bailout. Bad-loan charges fell by half,and its earnings beat analysts’ expectations.

Barclays,which avoided having to take government money during the crisis,said last week that first-half profit rose 29%. Meanwhile,HSBC said net income doubled. Most surprisingly of all,RBS is making money again. The most prominent casualty of the credit crunch said last week it had swung back to a modest profit for the first time since 2007. Two years ago,RBS was a basket case that looked like it should have been put out of its misery as fast as possible. That it is profitable again is a testament to the recovery powers of any institution. At this rate,the government should even end up making a profit on its stake in the bank.

Obviously it is better that the banks are doing well again. British taxpayers don’t want to be permanently subsidising a bunch of loss-making companies. But there is a danger: The UK may become complacent about the need to change how its financial system works.

The new coalition government,led by David Cameron,has already announced a review of the structure of the banking industry. Chancellor of the Exchequer George Osborne said in June that former Bank of England Chief Economist John Vickers would lead a panel on the future of banking. It will examine whether lenders should be forced to separate their retail and investment arms. The results are expected next year. Why so long? There’s no point waiting another year to review all the evidence. We already have all the facts. The arguments on both sides of the issue are well-known. The time to break up the banks is now.

Britain is a medium-sized economy,with an oversized financial industry. RBS grew to be one of the largest banks,trading and lending money in every corner of the world. But when it ran into trouble,it was the UK taxpayer who had to sort out the mess,and pick up the bill. It was affordable once—just about—but it won’t necessarily be so a second time around. If HSBC or Barclays ran into trouble,it could turn the UK into another Iceland,a country bankrupted by the risk-taking of just a few.

The solution is simple: Protect the retail banks,which collect deposits from ordinary people. Then leave the investment banks to sink or swim depending on the sharpness of their wits. If the banks don’t like it,they are free to shift their headquarters to New York or Shanghai and let some other government take ultimate responsibility for their solvency. The British can’t afford the risk anymore. A year ago,the banking system was too fragile to take such action. You don’t attempt heart surgery on a patient right after a bad car crash,no matter how necessary it might be. You wait until they have regained their strength. The banks are now out of intensive care. That means they are ready for an operation. A year from now,it will be too late.

Bank profits are recovering steadily. With interest rates so low,house prices steady and growth resuming,they will be minting fortunes again soon. What happens then? They will look like world-beating institutions. They will be making big donations to the main political parties and hiring lobbyists to make the right connections. They will also be paying billions of pounds in corporate taxes,useful revenue for a government that had a budget deficit equal to 11% of gross domestic product in the last fiscal year. In those circumstances,it will be very hard for a government to say. “Sorry,we don’t care how well you are doing,and we don’t care about all the tax you pay. We’re breaking you up anyway.”

If the UK doesn’t shrink its giant banks this year,it never will. And the government will only have itself to blame if it runs straight into another financial catastrophe a few years down the road. Britain won’t be able to afford it.