Small is beautiful, or at least to be welcomed

George Osborne, in a major speech on the economy yesterday, did some thinking out loud and suggested that the nationalised banks could well be broken into smaller ones on resale into the private sector.

In essence the argument is that if there several smaller banks, and one failed, for whatever reason, that that one could be allowed to fail. If you have only three huge banks, and one gets into difficulties then that cannot be allowed to fail.

Failure is important in a market system. In general it drives out the weaker, less profitable and uncompetitive units but (and here is an important point) the assets of the failed unit may be purchased and used more productively by the other or new banks.

One of the reasons for our banking failure was that the bigger ones were the result of merger and takeover of other banks, building societies, investment companies, insurance companies, etc. When individual account holders began to reduce their saving, and increase debts, because of the low interest rates available because inflation was controlled by massive cheap goods from overseas, the banks had to look elsewhere, and regulation was not up to seeing what they were doing.

The banks looked for funds from their investment arms and then increasingly from sub-prime mortgage-derived toxic bundles, with the results we know.

Each bank and building society should be forced to rely on its own secure assets and its own judgement of risk, in the knowledge that it will fail and not be bailed out if it deserts sound principles of lending. If they fail then they should be allowed to - depositors are protected by law. The main losers are the shareholders who should be able to monitor and influence policy. Bad practices will be reported on and share prices will fall.

There is a different question if a bank grows large by organic grown, but this should be a very long term thing as takeover is ruled out as a way to size.