Ben Bernanke, chairman of the Federal Reserve, yesterday told us what he thinks is the most important lesson to learn from the financial crisis. Drum roll. And the answer is?

By Damian Reece, Head of Business
Published: 6:15AM BST 03 Sep 2010

Putting a stop to banks that are "too big to fail", according to the testimony he gave yesterday to the Financial Crisis Inquiry Commission in Washington.
This is not a conclusion that will surprise many or cause controversy. The question, however, for Bernanke and his UK counterpart Mervyn King, is how exactly?
In the US, central bankers and regulators believe an end of too big to fail will result from changed and improved regulation, stemming mainly from the new Dodd-Frank legislation. There is now a framework in the US designed to address so-called "systemic risk", where dangerous financial practices are identified and curtailed on an economy-wide basis, together with rules on how failing firms should be dismantled in an orderly way plus greater regulatory co-operation.
The debate in the UK is rather less settled. This is not necessarily a bad thing. We have an opportunity to get banking supervision right, as far as we can with Brussels breathing down our neck. But while it will never be perfect, we can ensure it's better than anyone else's.
The Treasury has begun an important consultation period on its reforms to regulation centred on breaking up the Financial Services Authority and placing bank regulation back with the Bank of England. The plan is to have a Prudential Regulatory Authority to supervise individual firms linked to a separate Financial Policy Committee to regulate systemic risks. So far so good.
But the Treasury's final plans will also be coloured by the findings of Sir John Vickers' Independent Commission on Banking set up by George Osborne. Its remit is to formulate policy recommendations by September next year in the exact area that Bernanke was discussing yesterday - too big to fail, otherwise know as moral hazard, and systemic risk. There are others, such as promoting competition, but these are the most important.
Government ministers such as Vince Cable, the business secretary, have already decided the Commission should conclude the best policy is to force banks to be broken up. Consumer-friendly retail banks, that simply take deposits and make loans, will be split from the "casino capitalism" of investment banking arms which took the sort of bets that created many of the losses at the heart of the financial crisis. A dotted line will be drawn and two separately capitalised and staffed business will be formed.
Unfortunately, as Sir John will find, banking doesn't work like that. The simple, utility banks imagined simply don't exist. Even the apparently most benign mutual building society routinely pays investment banks so they can play in sophisticated capital markets. This is to ensure that the essential social use of all banks – transforming short-term deposits into long-term loans – can actually take place. In other words, the boundaries between retail and investment banking are extremely blurred, if not invisible. Imposing an arbitrary dotted line, and then cutting along it, is far from certain to enhance efficiency, leading to consumers getting a worse deal, not a better one.
There are therefore plenty of senior voices in the Treasury who are determined to make sure that formal separation does not become Government policy.
Which brings us to what the Bank of England believes. As the future regulator, Mervyn King's views on this are crucial. He wants an end to banks that are "too important to fail", correctly identifying that small banks can be just as risky as large banks if they're allowed to assume the Bank of England will always act as a lender of last resort. Better regulation is step one to removing this moral hazard but step two, for King, is to break up banks so they are separately, and much more highly, capitalised. Shareholders in investment banks would have no recourse to lender-of-last resort facilities and would be liable, along with bond holders, for 100pc of losses. But this does not address the central problem of where you draw the dotted line. In reality it would be the proprietary trading desks of banks that could be unequivocally defined as "casino banking". These trade, or bet, with a bank's capital to generate profit. If hived off they would simply become hedge funds – the sort of solution envisaged by President Barack Obama back in January which fizzled out.
Whether such an arrangement would go far enough to satisfy King is uncertain. It may not, highlighting the looming clash, sorry debate, between the Bank and some in the Treasury who believe splitting banks is untenable. How deep those divisions will go and how serious the disagreements become will be fascinating to observe. If King doesn't get his way, what then?
One compromise would be to adopt the sort of solution envisaged by Lord Turner, currently chairman of the FSA. He thinks it's possible to force banks to separate their operations internally, and allocate separate pools of capital to fund them, all policed by the regulator. Again whether King would be happy to adopt Lord Turner's view is a moot point. It could be that the argument over how you solve too big to fail is the sort of argument that's too big to lose.