Have you ever wondered why the financial services industry is always the one that gets into scrapes? And how suppliers of sweets, washing machines, medicines and computers seem to get it right most of the time?

Well you’re not alone. A vocal minority of the great and the good – and probably a taciturn majority of the rest of us – are seething that the world economy has been kicked in the soft bits by malfunctions in an industry that has nothing harder to do than look after spare money.

One of the most eloquent complainers is the economist and Financial Times columnist John Kay. He is as angry with the banks as any militant trade unionist, yet his perspective is capitalist.

After all, this little escapade has cost the taxpayers of the US and Europe $9 trillion so far, if you include all the asset purchases, short term liquidity injections and guarantees. Much of that money went to rescue and support the institutions that had caused the problems.

Yet in any other industry, firms that sell faulty products or pose a risk to the public are swiftly punished, either by the state, through the courts or by market forces.

Kay believes he has a solution – ‘narrow banking’, which he expounds in a 50-page pamphlet just published by the Centre for the Study of Financial Innovation.

The idea is to isolate the parts of the financial system that are essential to the functioning of society – services we could not do without, even for a matter of hours, just as we cannot do without water and electricity.

In his view, these vital functions are deposit-taking and the payments system.

These services, Kay believes, should not be provided by large financial conglomerates as they are now, but ringfenced in simpler entities rather like the regulated utilities.

Since the state is always going to have to ensure that deposits and payments are safe, and will bail out banks when catastrophe strikes, we might as well admit this and police the protected functions vigilantly.

Insured deposits, Kay argues, should only be invested in government bonds, so that there is no public subsidy for credit risks taken by the bank.

Then if a bank failed, the utility functions could quickly be taken over and continued by a special administrator, leaving the rest of the bank to crash without severing the sinews of the economy.

As Kay points out, the trains kept running when Railtrack went bust, while Wessex Water, owned by collapsing Enron, kept pumping water and even honoured its bonds.

That meant it was safe to let the badly run parent companies die in the ditch, as they deserved. They were not considered so big or important that they had to be rescued.

Restoring true market discipline to the financial sector, in the form of a credible fear of total loss, is a dream shared by many market experts. Kay has worked out a plan for achieving it.

Unfortunately, that plan is likely to remain a dream, too.

The political debate so far about reforming the banking sector has been sluggish and craven – showing all the signs of a malaise that Kay has written about elsewhere: the huge political power of the investment banks.

By John Hay