Banks told to lend or risk state control

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Mervyn King hit out as he warned the country was facing a "long and hard path" back to balance the public finances, in the wake of Chancellor Alistair Darling's massive borrowing splurge.

Mr King also predicted that cuts to VAT would lead to temporary deflation in Britain for the first time in generations, with the retail price index going negative next year.

But in evidence to the Treasury committee in the Commons today, he said the "single most pressing" issue was the need to get credit flowing again.

Asked by Labour MP Andy Love if he had ruled
out "wholesale nationalisation" of the banks, he replied: "In time of financial crisis, it would be a very serious error to rule out measures which may ultimately prove necessary. It would be an extremely brave person who ruled anything out.

"It wouldn't be our first option, but remember: the Government now has a majority holding of shares in more than one bank. The United States has just acquired a very significant stake in Citibank, the biggest bank in the world."

Unusually, Mr King also issued a clear signal that the Bank of England was ready to slash interest rates further and deeper than necessary, partly because commercial banks were building a "wedge" between their own rates and the Bank of England one.

"We will take whatever action is necessary on interest rates to steer the economy back to calmer waters," he said.

His remarks came as the Treasury, Bank of England and Financial Services Authority issued a plan to monitor the lending practices of institutions.

And a Treasury report warned net new mortgage lending is set to drop to zero next year.

The Governor backed Mr Darling's £20 billion gamble to drag Britain out of recession, saying the measures in yesterday's pre-Budget Report seemed "perfectly reasonable" given the "extraordinary circumstances".

He warned further banks may have to be recapitalised with public funds, while those currently receiving cash may get more.

At present the £37 billion bailout scheme applies to Royal Bank of Scotland, LloydsTSB and HBOS.