Calling the bankers' bluff over tax

It's fortunate for a number of reasons that the British Airways cabin crew strike has been averted - not least because disenchanted London bankers can head for Heathrow airport right now, if that's what they really want.

The argument that banks and bankers are highly mobile and would leave London if provoked is endlessly deployed to defend bonuses, but it is not interrogated nearly enough. Now Andy Haldane, the Bank of England's head of financial stability, has called the bankers' bluff. He is on safe ground to suppose there will not be overspill in the departure lounge.

Hedge funds and small financial outfits might be reasonably footloose, but big banks are much less so. And where would the refugee bankers, fleeing cruel persecution in Britain, find sanctuary? If they really want to turn their backs on advantages such as the English language, the favourable time zone, the world-class cultural life and the honeypot of business services in London, they would have to find a jurisdiction prepared to underwrite their activities.

Tax havens such as the Cayman Islands have been overbalanced by the credit crunch and would not be capable of doing so. Traditional magnets such as Switzerland are stretched to breaking point by supporting their existing banks - they would not want to take on responsibility for any more. And why would the US, or China, contemplate burdening their taxpayers with institutions that define themselves as too buccaneering for Britain?

I'm not sure what the optimal size of the financial sector is, but given that taxpayer bailouts are an integral feature of the industry, occurring periodically and costing more each time, it is not in the least obvious that bigger is better. Proportionately, public sector interventions in Britain during the financial crisis were much larger than in the US or the euro area, reaching more than 70 per cent of GDP this year.

The problem with relying so heavily on financial services is that we are hanging our national fortunes on a sector that is potentially very lucrative, but also ruinously risky.

Health, not size, is key.

Haldane's comments are not only interesting in themselves, but because they appear to be a harbinger of a tougher stance. The Bank of England's latest financial stability report urges the banks to replenish their capital now, while the sun is, if not shining brightly, at least casting a few wintry rays.

It wants to see them start a virtuous circle, by retaining more capital instead of paying bonuses and dividends. That would send down the cost of funds, which in turn would get credit flowing through the economy. Non-financial companies would then perform better, resulting in lower loan losses for banks.

In the long term, everybody's happy. In the short term, bank shareholders will squeal - share prices have already fallen in response to the Chancellor Alistair Darling's bonus tax - and the bonus lobby will cry that it is infringing their basic human right to the moolah.

The bank's exhortations come against a background of international reform. The Basel committee on banking supervision is suggesting a series of measures, including proposals that would limit the ability of banks to pay bonuses and dividends if their capital dropped close to the minimum required.

The system looks more stable and more resilient than it did six months ago, but there is a very difficult road ahead. Next year, we can expect progress on an international level on improving the regulation of capital and liquidity.

It will take longer to resolve two parallel debates: The first is around dynamic provisioning - or whether central banks can let the air out of bubbles before they burst, by insisting that banks build up cushions of capital in the good times to soften their landings in the bad. The second is about firms that are too big to fail - how they can be wound up with the least possible damage, and whether there should be a separation of utility banking from the casino variety as I have advocated, and far more importantly, as has the bank's governor, Mervyn King.

People are calling this an "ice age" for bankers, but it is blatantly premature for them to be receiving bonuses off the back of free money injected by central banks, at a time when there are still enormous risks.

Some individual households are very highly leveraged and vulnerable to a rise in interest rates. Potentially bad loans in the commercial property sector are looming like a black cloud: £160 billion ($364 billion) of loans are due to be refinanced by 2013. So far, we have only had a liquidity crisis - the real credit crisis is yet to happen.

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