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Bank reform needed, says Deputy Prime Minister Clegg

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Media captionMr Clegg said the banking system needed to be made safe

Deputy Prime Minister Nick Clegg has told the BBC the UK banking sector must be reformed so taxpayers are never again liable for its mistakes.

He said he was "attracted" to the idea of splitting up banks into separate retail and investment businesses.

He also defended the government's decision to raise VAT to 20%.

Mr Clegg's comments come the day after the head of the coalition government's review of banking called for wide-ranging reform.

"We cannot as a country ever tolerate letting the banking system get so large it becomes a massive liability to the UK economy," the deputy prime minister told the BBC's The Andrew Marr Show.

He said the collective liabilities of the UK's banks were currently four times larger than the entire economic output of the economy.

"We have to insulate the economy and the taxpayer from carrying these liabilities," he said.

"We need to have a sustainable and prosperous banking sector where the taxpayer is not liable."

Mr Clegg said he was attracted to the idea of separating the trading arms from the retail arms of big banks, which is why the government had set up the Independent Commission on Banking (ICB) to look at this option.

He did not, however, express any preference for how this would be done in practice. The ICB was "looking at all potential models", he said.

Above all, "the banking system needs to be made safe", he said.

VAT rise

Mr Clegg also attacked the previous Labour government for creating the conditions under which the financial crisis unfolded.

"Labour oversaw the City when it was gorging on bonuses and let the housing market become a casino," he said.

The new shadow chancellor Ed Balls was part of the administration that allowed these conditions to develop, he said.

Mr Clegg also defended the rise in VAT, which went up from 17.5% to 20% at the beginning of this month.

"The structural deficit was much bigger than we thought [when we came into government] - £13bn bigger," he said.

This was the amount of money the rise in VAT would bring to the government, he said.

"So far, I have heard no answers as to where else this money could come from."

Bank split

Mr Clegg was speaking a day after Sir John Vickers, head of the ICB and a former chief economist at the Bank of England, said plans to separate bank trading and retail operations were being looked at.

In a speech at the London Business School, Sir John said the failure of banks to efficiently manage risks had been "spectacular".

He said the shock from the fall in property prices in 2008 "should not have caused havoc on anything like the scale experienced".

One suggestion is that investment banks should be split up, so that depositors' money is not put at risk by the investment banking arms of the business.

Equally, if banks were allowed to collapse if mismanaged, taxpayers would not need to come to the rescue.

This is what happened when the last Labour government bailed out both Royal Bank of Scotland and Lloyds Banking Group when it deemed the risks to the wider financial system of allowing them to collapse were too great.

Sir John stressed that no final decisions had yet been made.

The ICB has until September 2011 to make its recommendations to the government.

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