Sighs of relief heard from the bankers' bunkers

He therefore reckons capital ratios up to 20 per cent of risk-weighted assets should be mandatory, about twice what Australia's big four banks now maintain. The commission also recommended that retail banking be ''ring-fenced'', meaning basic deposit-taking and personal and business lending would be strictly separate from banks' riskier wholesale and investment divisions.

Retail banks could still be part of larger financial groups, but ''ring-fencing'' would better align the costs of borrowing with the riskiness of the borrowed funds' use. British depositors' money would, for instance, no longer be available to clog the financial system with junk American loans.

The Chancellor of the Exchequer, George Osborne, indicated this week that he agreed with the recommendations. Yes, Australia avoided the worst of the GFC. Not a dollar of public money was spent to save the banks, notwithstanding the government lent the banks its AAA credit rating to help them borrow overseas.

But absence of a financial crisis in Australia does not mean the probability of a crisis was, or is, any different from in Britain. Should Australian house prices, say, fall as they have done in the US, and unemployment to rise significantly, Australia's banks - and, therefore, taxpayers - would be on the hook. APRA should consider the Vickers proposals as well.

To its credit, the Australian Prudential Regulation Authority will introduce the Basel III changes in Australia by 2016 rather than 2019. And the Australian government has announced it will slash its deposit guarantee to $250,000 from $1 million, mitigating public support for banks.

Australia's banking system resembles Britain's: a handful of large retail banks dominate and offer investment banking services on the side. And Australian taxpayers also provide a huge implicit subsidy, worth billions annually, to Australia's major banks.

At a minimum, APRA should avail itself of the scope within Basel III to make capital ratios permanently higher. It should not kid itself that it can tweak capital ratios according to the ''state of the economic cycle''. The International Monetary Fund was lauding banks' risk management in the lead-up to the financial crisis.

Higher local capital ratios would help competition among financial institutions. As the implicit subsidy to big banks dwindled, their ability to borrow more cheaply than smaller banks - even when their capital ratios are lower - would fall away.

Tighter capital requirements would cut banks' earnings in the short run (more debt boosts returns for banks as much as it does for any business), and probably push up the cost of loans a little too. But these are small prices to pay for financial stability.

In an ideal world, banks would be subject to no government regulation at all. They could manage their own risk, and depositors would choose who to trust with their money.

Alas, the GFC showed that it is impossible for democratic governments to let large financial institutions fail, however much they should. It is a government's job to free taxpayers from unwittingly providing unfair, distortionary, and imprudent subsidies.