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British central bank urges reform

The Bank of England warned banks had overextended themselves during the economic boom years, lending out more than they were getting in, which helped cause ‘arguably’ the largest episode of instability since the first world war.

In its bi-annual financial stability report, the bank's deputy governor, John Gieve, called for ‘a fundamental rethink of how to manage systemic risk internationally’.

The government was forced to re-capitalise three of Britain's high-street banks earlier this month in a 37-billion-pound (64-billion-dollar, 47-billion-euro) deal. Other nations followed suit with their ailing banks.

‘Early signs suggest these measures have helped underpin the banking system,’ the report said, but it warned systemic problems remained that would allow banks to repeat their mistakes.

It noted the overextension problem -- in 2001, customer lending in Britain was roughly comparable to customer deposits. By 2008, banks were lending 700 billion pounds more than the deposits they were getting in.

It proposed a new ‘leverage ratio’ -- a minimum ratio of capital to total assets to which individual banks must conform, to restrict their expansion relative to their stock of capital.

It also backed a system of ‘dynamic provisioning’, which would force banks to build up reserves against future losses in the good times, which they could then draw on when times were tough.

‘We need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the dangers they bring to the wider economy,’ Gieve said.

‘That means not just increasing capital and liquidity requirements for individual institutions but relating them to the cyclical growth of risk in the system more broadly.

‘Counter-cyclical policy of that sort should complement regulation of companies and broader macroeconomic policy.’

The report estimated that governments around the world have spent more than 750 billion pounds so far in helping ailing banks.

But it says the world's financial institutions have racked up losses worth a huge 2.8 trillion dollars (1,800 billion pounds) since the credit crunch began.