Yesterday it was the UK’s Financial Services Authority with a discussion paper containing some quite dramatic suggestions for reforming home lending in the UK, today the head of the Bank of England, Mervyn King, has gone much further and called for the complete break up of UK banks to be considered as the best way to reform the financial system.

His call, the most radical yet from the head of a major central bank or regulator, puts him at odds with the UK government, with the Financial Services Authority, and with other regulators and worldwide governments that are moving to stiffen prudential controls over banks and force them to hold more liquid capital on their books.

King wants a break-up of banks to prevent them becoming “too important to fail”.

In his speech overnight in Edinburgh, said it was “a delusion” to think toughening regulation would prevent future financial crises.

“By international standards, UK banking is highly concentrated. There are four large UK banking groups. Of these four, two are largely in state ownership and their assets are a multiple of the assets of the next largest bank. If unsustainable capital flows provided the fuel and an inadequately designed regulatory system ignited the fuel, the past two years have shown how dangerous it is to let bankers play with fire,” he said.

“The sheer scale of support to the banking sector is breathtaking. In the UK, in the form of direct or guaranteed loans and equity investment, it is not far short of a trillion (that is, one thousand billion) pounds, close to two-thirds of the annual output of the entire economy. To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.”

It’s a message with some echoes in Australia where we have four big banks that now dominate our economy to an extent that they appear to be too big to fail. That has never been spelled out by the federal government or by regulators who appear intent on managing their size, as do regulators in other countries with their huge banking groups.

Australia is different though to the UK banking industry. Except for New Zealand, where our banks dominate (and the ANZ’s return to increasing investment in Asia), the Big Four here are essentially domestic in nature. But it must be said that our banking and financial crises have been homegrown, with the last bad crunch the property implosion in the recession of the early 1990s. And our banks did lend heavily to financial engineers and geared groups such as MFS, ABC Learning, Trico and Allco, not to mention Babcock and Brown.

But overall, the UK banking sector is far more international and far more exposed to the siren call of funny-money investments offshore, which were also imported into the sector from the US and other economies through the now rejected originate-and-distribute model of spreading risk (which also spread and increased leverage and ended up reducing liquidity).

King pointed out that two years ago, Scotland was home to two major world-class banks, the Royal Bank of Scotland and HBOS. “Both are now largely state-owned,” he started his speech

“Banking has not been good for the wealth of the Scottish — and, it should be said, almost any other — nation recently. Over the past year, almost six million jobs have been lost in the United States, over 2 ½ million in the euro area, and over half a million in the United Kingdom. Our national debt is rising rapidly, not least as the consequence of support to the banking system. We shall all be paying for the impact of this crisis on the public finances for a generation.

“It is hard to see how the existence of institutions that are too important to fail is consistent with their being in the private sector. Encouraging banks to take risks that result in large dividend and remuneration payouts when things go well, and losses for taxpayers when they don’t, distorts the allocation of resources and management of risk.

“Although there are no simple answers, it is in our collective interest to reduce the dependence of so many households and businesses on so few institutions that engage in so many risky activities. The case for a serious review of how the banking industry is structured and regulated is strong.”