The Government did the right thing at the right time when it rescued the banking system last October. We said it then and it’s only fair to say it again now. The banking system looked into the abyss as lending dried up overnight. Lending guarantees and recapitalisation were the right responses. They worked. There was also a grown-up recognition that nationalisation, albeit temporary, was a necessary response to a banking crisis where vast sums of public money are involved.

From the heights of October, however, it has been downhill all the way. Policy has been confused, contradictory and weak. Today Alistair Darling has to recapture the high ground — if he can, with his credibility so shot.

The central problem is lack of clarity over what the big, semi-nationalised banks are supposed to do. They are being told to hoard reserve capital and shrink their balance sheets like other banks. But publicly owned banks are safe. They have no need to hoard capital. They should prioritise lending to solvent British companies and families.

There is, still, a credit crisis. Sound British companies, small, medium and large, many with good prospects and credit history, are being squeezed by bank demands to cut working capital or provide additional security or pay extortionate fees and interest margins. Banks say they must be more cautious and risk averse in a recession to protect their balance sheets. But the recession is being reinforced by tight credit conditions aggravating, not reducing, the problem of bad loans.

There are lending agreements with semi-nationalised banks. But agreements should have been instructions, as has now belatedly occurred with Northern Rock. We own these banks, after all. Apologetic politeness can be a virtue but not when it is abdication of leadership. The politeness, of course, is deliberate and lies in an early decision to manage government shareholding via an “arms length” holding company, UKFI, which from the outset has been largely passive. At no stage has the UKFI or the Treasury spelt out how the taxpayer interest is being looked after.

It is clear from its behaviour, however, that the Government’s overriding objective is to return publicly owned banks to the private sector as soon as possible. The evidence for this is the preoccupation with building up reserve capital when it serves no purpose; Stephen Hester’s outrageous short-term RBS bonus, and the apparently well- founded stories circulating the City that buyers — Tesco? Sir Richard Branson? — are being sounded out for a fire sale of the better bits of Northern Rock (leaving the rubbish with the taxpayer). A dash for cash would cost the taxpayer dear.

The Government has a terrible record of selling off assets too quickly and cheaply. All previous experience from other countries that have had banking crises — Sweden, Israel, South Korea, the US with the Continental Illinois bank — is that the taxpayer can be protected, even make money, if governments are patient and wait, perhaps a decade, to realise maximum value.

The Government’s obsession with minimising its equity stake has led it into the quagmire of the Asset Protection Scheme. Under this highly opaque arrangement, vast amounts of bad RBS and Lloyds Group loans are being “insured” under an arrangement whereby the banks take a 10 per cent hit and the taxpayer takes a risk on assets the Treasury does not understand, cannot value properly and that are probably worth less than it hoped. This is a scandal and it must be stopped.

Today’s White Paper should also describe the architecture for future banking in the UK which cannot simply involve re-erecting the same high-risk, jerry-built structures that collapsed in the earthquake. Some of these structures were fairly simple, such as the (mainly) demutualised building societies that lent recklessly, fuelling the residential and commercial property booms. These will have to be more firmly regulated and supervised in future. Some, like RBS, were big and complex. I start with Mervyn King’s clear, correct, statement that banks that are too big to fail are too big. Period.

Whether the big banks are cut up by a butcher’s cleaver or subject to the regulatory equivalent of keyhole surgery is a second order question. What must be clear is that if the directors of Barclays Capital, or its equivalent, want their bank to become the world’s largest casino that’s up to them, but only if there is no question of the British taxpayer guaranteeing it.

Until that surgery is complete, the Government cannot continue to offer guarantees and lend last-resort facilities to private sector banks without a reciprocal assertion of public interest. All institutions underpinned by the State should be required to follow guidelines governing bonuses, lending strategy, the payment of UK tax and consumer protection. They might not like it, but they will have to lump it.

There is a battle royal being fought out over the scale and scope of regulation. There is some common ground: mindless, bureaucratic box-ticking has to give way to a form of supervision that identifies systemic risk; there is also agreement around the concept of “macro-prudential” regulation, with the Bank of England in the lead.

There are powerful forces arguing for the return to the status quo ante. We are being told nothing should be done to inhibit “innovation” or the “competitiveness” of our financial institutions. If the Chancellor has any bottle, he will say we have had too much financial innovation. And industries that fail or put too much risk on the rest of the economy are not in our national interest. Ask the millions who will lose their jobs and the thousands who will lose their homes because City gambling was allowed to get out of control.

Vince Cable is deputy leader of the Liberal Democrat Party

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