George Osborne had a tough message for Britain's banks yesterday.

Woe betide any bank that failed to separate its High Street retail business from the casino-style operations of its merchant banking arm. A Sword of Damocles will descend and slice it in two. Or, in the jargon of the Parliamentary commission on banking, he will "electrify the ring-fence" that is meant to separate the two parts of the business. Strong words, eliciting images of blood and burning flesh.

The Chancellor says he wants 2013 to be the year when British banking turns over a new leaf and public anger is channelled into real change. Yet only a few months ago, both Mr Osborne and Business Secretary Vince Cable – the man who used to voice public anger about banks so effectively – were resisting the idea of separating banks for fear of inhibiting lending. Of course, what has changed since then is the Libor scandal, which revealed how our major banks manipulated inter-bank lending, and the revelations about the mis-selling of hedging products on business loans.

Loading article content

It is hard to know whether the Chancellor has undergone a true Damascene conversion on the separation issue or is merely trying to appear strong. His Banking Reform Bill, launched yesterday, contains some useful measures. Switching accounts will be easier and quicker in a sector noted for inertia. And Britain's backward payments systems (BACS, CHAPS, and so on) will be overhauled.

However, will this legislation be capable of delivering the change in banking culture Mr Osborne referred to yesterday? Though better capitalised than in 2008, banks will still be able to lend £33 for every £1 on their balance sheets.

The biggest issue about banking competition is that there simply are not enough of them and this legislation is unlikely to change that. Meanwhile, how can the still lavish bonus culture be justified in an industry that has seen thousands of redundancies? And why is lending to small businesses still falling?

Given the Coalition's past form, the fear must be that the devil is in the detail. What would trigger enforced separation of retail and merchant banking? In five years' time could the investment arm of a major bank go bust without damaging the entire economy?

Mr Osborne rightly identified the key question yesterday. Referring to the bail-out of RBS, he said: "I want to make sure the next time a Chancellor faces that decision, they have a choice. To keep the bank branches going, the cash machines operating, while letting the investment arm fail."

At the moment fear of another RBS-scale collapse may be keeping bankers in check. The danger would arise with the return of a bull market, tempting investment bankers to reprise to their bad old ways.

A sword is useless if it never leaves its scabbard. And a mile-high electric fence, powered by 10,000 volts, will not contain a field of rampaging bulls if it is never turned on.