King vows bank aid in bad times and good

The credit crunch, which has seen banks almost stop lending to each other, led to the Government takeover of Northern Rock and has forced High Street banks to raise more than £16 billion of new cash fromshareholders.

Addressing the British Bankers Association annual conference, King pledged to follow up on the Special Liquidity Scheme, set up last month to offer banks access to up to £100 billion of liquid assets in return for more risky ones like mortgage-backed securities.

"We intend to learn from the experience of the scheme to put in place a liquidity facility that works in all seasons - both 'normal' and 'stressed'," King said. "It will be part of a set of reforms to our Red Book, to be announced later this year." But he told the bankers that in return for such a scheme they will have to behave more responsibly.

"It is often said that the role of a central bank is to take the punch-bowl away just as the party gets going," he said. "That approach has worked well in monetary policy. But all those efforts will come to nought if the opposite applies to the financial sector.

"If banks feel they must keep on dancing while the music is playing, and that at the end of the party the central bank will make sure everyone gets home safely, then over time the parties will get wilder and wilder."

King said that he wanted to overcome the "stigma" problem that has "plagued the use of central bank facilities throughout the crisis". He added that during his second term as Governor he wanted to "establish a framework for financial stability that is on as sound a footing as the one we have successfully established for monetary stability".

The subprime crisis and credit crunch had set major challenges which all central banks are grappling with. The Governor admitted these will "not be easy to overcome", and went on to warn the bankers that, when a new deposit insurance scheme comes in to protect them, they will have to pay according to how likely they are to fail.

The scheme is being reformed in the wake of the run on Northern Rock which eventually led to the nationalisation of the former building society. To halt the run, the Government was forced to step in to say it would guarantee savers' deposits above the then limit of £31,700.

King said he agrees that there should be 100% insurance of deposits, up to a limit, but added that this limit should not be too high. He said the banks will probably have to pay up front for the scheme, and that "to limit risk-taking by banks there is also a strong case for relating the payments made by different banks to finance the insurance scheme to the risks that they will fail.

"A degree of pre-funding is one of those ideas that is bound to be unpopular before the fund is called upon, but seems decidedly wise after the event as it lessens the burden on the banking system in a time of stress."