Would the best option for the banking system in an independent Scotland be 'Vickers on steroids'?

As the debate about the benefits (or otherwise) of an independent Scotland continue to hit the headlines, it's worth considering the argument about what will happen to the banking sector if the country goes it alone.

As anyone working in one of the largest banks north of the border will testify, a lot of the pain felt in the both RBS and HBOS (now Lloyds Banking Group, obviously) over the last three years was largely as a result of activities outside of Scotland.

In 2008, of the 200,000 people working in HBOS or RBS, just one in six were based in Scotland.

A new report called Scotland's Economic Future, edited by economic Professor Donald MacKay and supported by think-thank Reform Scotland, says that the best future model for financial institutions north of the border would be to separate retail and commercial banking from investment banking entirely.

Suggestions for ring-fencing retail operations from riskier investment banking activities have already been outlined in a report from the Independent Commission on Banking, chaired by Sir John Vickers.

However, Professor John Kay, who penned the report on the future of Scottish banking, says that the "best future model" is one in which "the utility of normal commercial banking is separate from the casino of investment banking - Vickers on steroids".

This doesn't mean that either RBS or Lloyds would be forced to pull back from investment banking - although the former seems to be doing so of its own accord - but that the Scottish government shouldn't foot the bill if something went wrong.

Scottish banks should insist on a "subsidiary structure" whereby the host country assumed the obligations for these activities, says the report. In the context of an independent Scotland, this means that England would be responsible for most European wholesale banking activities of both Lloyds and RBS.

The report admits this could impact on Scottish institutions' competitiveness, but says any policy should "in no circumstances include implicit or explicit guarantee by the Scottish taxpayer of trading activities located in London or New York".

More recently, the investment banking activities of RBS have switched from being a driver to a drain on profitability. What's more, while the bank continues to bolster headcount in its Scottish HQ, talk of ever more significant redundancies in London continues to emerge.

The debate about what to do in with the banking sector in the future is framed within theories about what would have happened to banks north of the border had Scotland been independent back in 2008.

The three options would have been the Scottish government guaranteeing the banks' liabilities itself (impossible because of the cost of such a move); tapping international support (unpalatable because of the conditions imposed by other states) or the "least bad" option of allowing the companies to go into administration while the Scottish government took control of local retail and commercial banking activities.

If RBS had been allowed to fail, the impact on global markets would have been "greater than the consequences of the collapse of Lehman". One small upside, however, would have been that the process of administration would have "provided lucrative employment for Edinburgh professionals for many years".