Leading article: The days of supine banking regulators must end

American reform moves appear more serious than those in the UK

Does the blame for last autumn's catastrophic meltdown of the global financial system lie in bank boardrooms or in regulators' offices? Alistair Darling sought to emphasise the culpability of bankers in his Mansion House speech yesterday. The Chancellor is certainly right to argue that managers must not be allowed to evade moral responsibility for the fact they brought their institutions to the brink of ruin through reckless lending. But we have surely also learned enough about the recent behaviour of the Financial Services Authority here in Britain and the US Securities and Exchange Commission to know regulators were also asleep at the wheel. Banks and insurers were allowed to take on staggering amounts of risk without these watchdogs raising the slightest objections.

The reality is that it took both incompetent management and supine regulation to drive the global financial system over the edge of a cliff last October. Both of these failings need to be addressed if we are to minimise the likelihood of a repetition of that disaster.

And, on the regulatory front, the Obama administration seems to be making a rather more serious reform effort than our own Government. Yesterday, the US President announced, among other things, plans to rein in the terrifyingly bloated and opaque derivatives market, to require banks to hold more capital in boom times and to monitor the activities of hedge funds. The underlying thrust of the proposals is right: if a financial institution is deemed to pose a systemic risk to the economy, it must be brought under the regulatory umbrella. Of course, regulation creates, by its very nature, inefficiencies and bureaucracy. But, as we have seen, these disadvantages are dwarfed by the damage that an unregulated financial sector can wreak on a society.

Our Government has indicated that it will impose many similar measures on UK banks. But the tone Mr Darling adopted last night was considerably less forceful than that of his counterparts in the US. The Chancellor's refusal to countenance a shake-up of the tripartite regulatory structure (the FSA, Treasury, Bank of England) suggests an inability to grasp just how spectacularly this system was found wanting.

Yet, in truth, neither our own Government nor the White House seem prepared to countenance the sort of radical measures that would really transform regulation of the financial services: splitting up the banking empires. As long as a single institution can combine the inherently risky "casino" activities of investment banking with the "utility" banking function of taking deposits and lending to companies and individuals, the sector looks destined to remain inherently vulnerable.

One lesson of the past year is that no government will sit back and allow ordinary depositors to lose their money when a bank is at risk of going bust; a rescue will always be forthcoming. The problem is that this safety net encourages reckless behaviour. As long as speculators and their managers know they can fall back on state support should their bets go wrong, they have an incentive to engage in ever bigger gambles. Heads the banks win; tails they do not lose.

A thorough regulatory overhaul of US and British banking is needed. But this new regulation ought to be accompanied by a commitment to ensure that there will be no, or at least fewer, players out there deemed too big or influential to be allowed to fail.