In his editor’s letter in today’s City AM, Allister Heath outlines the Danish approach to bank reform:

BELIEVE IT or not but Denmark has emerged as Europe’s pioneering financial reformer. We need to learn from it. Fjordbank Mors, a small lender, has just been allowed to go bust; taxpayers are not having to shell out a penny and the world hasn’t come to an end. Senior bondholders at Fjordbank Mors are taking a massive hit, shareholders are losing everything, the management is being sacked, depositors with more than the maximum guaranteed by the deposit insurance scheme are losing out (tough, but necessary) and the taxpayer is being protected.

This is the second time this happens under Denmark’s new resolution procedures designed to allow an orderly, controlled failure of banks and thus reintroduce profit and loss discipline into the industry…

As Allister suggests, this is precisely the sort of approach that we should be taking in the UK. We need to put measures in place to allow the orderly winding up of failed banks, without them threatening the entire banking system or becoming a burden on the already overstretched taxpayer. And we need to do this urgently – if European sovereign debt goes the way of sub-prime mortgages, and another financial panic starts, not all of our banks will be able to weather the storm. In a rational world, we’d have got ahead of the game and done this a couple of years ago rather than obsessing about bankers’ bonuses. But hey, better late than never.

Allister’s conclusion is a compelling one, which I would endorse wholeheartedly:

Some Danish bankers are complaining that their cost of finance has shot up as credit rating agencies now assume a larger risk premium. But that is no bad thing. Everybody needs to face an accurate cost of capital. It should be neither artificially high nor artificially low. The removal of government guarantees is a good thing. It will lead to a better allocation of resources, a more rationally managed financial sector and correctly priced credit, reducing the risk of bubbles. Most important of all, it will allow the City to regain the moral high ground, which it lost when it was bailed out. The real problem in finance has been too little capitalism, not too much. Reforms need to be put into place to ensure that even large banks can be weaned from state guarantees and subsidies. It will be great news for the City’s long-term prospects if the Danish experiment succeeds.