THE news that a trader has lost $2 billion at UBS is quite a shock. All the banks were supposed to have reviewed their system after the Jerome Kerviel affair to prevent this kind of thing from happening; trading positions should be limited, accounts reconciled on a daily basis etc etc. It will be fascinating to find out how it happened.

The loss comes hard on the heels of the publication in Britain of the Vickers report on banking reform and will doubtless be used as evidence in the debate. Indeed, my inbox already includes this comment from Sonia Falconieri of the Cass Business School that

While the separation of investment and commercial banking will prevent this kind of episode from impacting on depositors, it will not prevent further incidents from happening. Compensation packages with excessive bonuses and unrealistic targets are the reasons for excessive risk taking among traders, particularly at a moment of high financial instability that makes difficult to achieve the required targets. This together with a loose internal control system makes investment banks vulnerable to rogue trading.

We ought to be able to agree on two things. First there will always be bad lending decisions, rogue traders etc. But second, the government should act to ensure that, as far as possible, the costs of these crises do not fall on the taxpayer. It seems to me that the Vickers report is headed in the right direction.

There is something different about retail banking in that it oils the wheels of the economy, ensuring that payments are made between employers and workers, customers and shops. Furthermore, the experience of 1930s bank failures persuaded authorities round the world to insure deposits. This is a subsidy to the banks in the sense that depositors do not differentiate between the weak and the strong, and this lowers the cost of funding.

While this subsidy is justified in public policy terms, the same does not apply to investment banking. Of course, some of the services offered by investment banks are useful; the provision of liquidity to markets, for example, or risk management to companies. But such services can be provided by other sectors (hedge funds, insurers) which don't benefit from a public subsidy. The danger was that, in the run-up to the crisis, universal banks used the benefits of cheap funding to speculate in a way that enriched their employees in the boom but left the taxpayer with the losses in the bust.

This is NOT to say that retail banking isn't risky or didn't run into trouble in the crash; of course, it did as the examples of Northern Rock and HBOS showed. Indeed, that is why the Vickers committee wants the retail banks to take on extra capital to provide a greater cushion against the risks, while leaving the investment banking arms to meet the Basle rules (thus not disadvantaging them against their competitors). Will this lead to a greater cost of funding for small businesses? In yesterday's FT, John Kay wrote that

The assets and liabilities of British banks exceed £6,000 billion, four times the country's income. Lending to UK businesses accounts for about £200 billion of that, or 3 per cent of the total.

So it is not clear why higher capital costs should fall exclusively on business lending; if they do, that is the bankers' choice. And those higher costs may well be offset, as the report suggests, by the reduced cost of future crises.

A certain degree of cynicism about the ability of regulators to spot future banking problems, or the ability of the banks (and other sectors) to get round the rules, is understandable. But surely we can't go on as we are, with all Swiss taxpayers theoretically responsible for UBS's inability to control its traders? Taxpayers and public sector workers are being asked to make many sacrifices at the moment; this is not a cost they should be asked to bear.

As for the bankers, they remind me of the post-1815 Bourbon monarchs who had "learned nothing and forgotten nothing". They still see themselves as masters of the universe rather than as servants of the taxpayer as a result of their previous mistakes. Of course, the crisis wasn't all the fault of the banks but there were still plenty of errors of judgment that cast extreme doubt on whether they deserve their high salaries. Investment bankers claim to be in favour of free markets so let them prove it by cutting themselves off from the public purse.

UPDATE: Just to emphasise the point, see Martin Wolf in today's FT.

Thank you, UBS. As a member of the UK's Independent Commission on Banking, under Sir John Vickers, I could not have asked for a better illustration of the unregulatable risks to which investment banks are exposed than Thursday's announcement of a loss of $2 billion in unauthorised trading. No sane country can allow taxpayers to stand behind such risks

In response to one comment, UBS took a hit of $2 billion this time without troubling taxpayers, but what if the next hit is $20 billion? Who can be confident the bank's risk managers will limit the loss in time?