Mervyn King, Bank of England Governor, suggested in his Mansion House speech this week that the banks should be cut down to size. He mooted restricting the size of banks and splitting investment banks from retail banks – to stop them becoming too big to fail which forces the taxpayer to bail them out.

It’s all part of a continuing battle with the Treasury for more power to be given to the Bank to regulate the industry. Yet one of the reasons why Northern Rock went belly up and required a bailout was the Bank’s dithering before the run on it and afterwards. Mr King at that stage was unduly concerned about creating “moral hazard” – bankers might be less prudent if they knew they would be bailed out by the government. The Bank had all but closed down its financial stability monitoring operation in the months before the credit crunch, and was very slow to react as the crisis gathered pace.

It is very convenient to blame the bankers, and some of them certainly behaved very badly and deserved to lose their jobs and accumulated wealth. But everyone knew lending was too cheap, loans were being provided without proper checks and that asset prices had blown up into a bubble. So where were the regulators like the Bank and what was the government doing?

The large Spanish banks haven’t had the problems experienced elsewhere in Europe because they were better regulated. The lesson of the financial crisis isn’t that banks had become too big, but that those charged with regulating them were asleep on the job.

(posted by John Willman)

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