THE Barclays LIBOR scandal has shifted the nature of the debate over whether retail and investment banks should be split up. Within British political circles, there is an increasing belief that poor culture at investment houses can infect the retail arm of a universal bank.

One of the greatest advocates of this view is Governor of the Bank of England Mervyn King, under whom responsibility for regulation of Britain's financial services will fall once the bill to bring the Financial Services Authority within the central bank passes through both Houses of Parliament.

"We don't build nuclear power stations in densely populated areas, nor should we allow essential banking services and risky investment banking activities to be carried out in the same 'too important to fail' bank," King said at a BBC Radio 4 “Today Programme” lecture two months ago. He finds support among several members of the recently established parliamentary commission on banking standards, headed by Treasury select committee chairman Andrew Tyrie. Of its 10 members, three are already of the view separation should go ahead. Nigel Lawson, Chancellor of the Exchequer under Margaret Thatcher, is a renowned advocate; John Thurso and John McFall feel similarly.

Mr Tyrie has not declared a position, though in his capacity as Treasury select committee chair in July 2011 he questioned why the Independent Commission on Banking headed by Sir John Vickers had already stated a preference for ring-fencing and ruled out the option of full separation. Within this independent commission, at least three of its members have already made up their minds.

Lord Lawson fears a crossing of cultures between the retail and investment sides of a bank. Competitors seeking a more level playing field against the perceived monopoly of Britain’s largest banks show support for this view, in particular Virgin Money’s chief executive Jayne-Anne Gadhia through her oral and written evidence given to the Treasury Select Committee’s April 2011 report on “Competition and Choice in Banking”. But this is because her competition would weaken in the event of a split, not because culture leakage is rectifiable via that measure. Morgan Stanley finds the idea of a split appealing on the grounds it will weaken its competition in securities, asset management, and credit services. But the benefit of vested interests is no reason to advocate a split.

Splitting up universal banks would mean the loss of an implicit government subsidy for risk-taking activities and address one of the root causes of the financial crisis, says Sir John in his original report. But that argument does not hold up taking into account Northern Rock’s bail-out, a purely deposit-taking institution, or the British government’s 40% ownership of Lloyds Banking Group—which is not an investment bank.

Sebastian Mallaby recently offered a different perspective in the Financial Times. He says that a division of retail and investment banking could benefit investors as well as give greater protection to customers. The latter point is justified, since the retail bank becomes shielded from losses suffered at the investment bank—though that can just as well be achieved by ring-fencing.

Bank investors do not want the profit-making part of institutions hived off, however. It was the revenues made by the investment arm of JP Morgan that helped it to survive the crisis of 2008-9, not its commercial activities. According to Sir John, in the event of a split, the remaining retail bank would hold even higher capital. For bank investors this is a worse rather than a better outcome, since more equity will be held up at the retail bank. Whether a split will improve financial stability is unquantifiable. Many financial analysts maintain that diversified income allows institutions greater sources of security, and that is a long-held view.

The idea that it can improve poor culture at investment banks stands on yet thinner ground. An investment bank operating alone rather than as part of a wider body has no incentive to behave any differently. After the LIBOR debacle, it is reasonable to examine the question of culture. But it is a jump in logic to assume a retail bank is necessarily contaminated by the existence of an investment arm. If a cross-over of culture is the real concern, perhaps a more fruitful exercise is to look at the backgrounds of those in charge at the disgraced universal banks. Bob Diamond transferred from Barclays Capital to become chief executive at Barclays Bank, Stuart Gulliver similarly moved from heading HSBC’s investment banking division to lead the group, while Stephen Hester at RBS began his career at Credit Suisse. Whether their mistakes are down to their investment-bank heritage or whether the most aggressive investment bankers are more likely to rise to the helm of universal banks (and steer them toward rocky shoals) is an interesting, and important, question.