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Bank of England governor warns 'innocent bystanders' may lose homes

Mervyn King today called for an improved system of financial stability for Britain as he admitted that prolonged turmoil in the markets had left the economy facing a period of rising inflation and weaker growth.

The governor of the Bank of England warned that the crisis of the past year was not over and that he wanted his second five-year term in office - which starts next month - to establish a framework for financial stability similar to that created by Gordon Brown for setting interest rates in 1997.

Addressing the British Bankers' Association in London today, King said he wanted financial institutions to hold more capital "as a shock absorber" to prevent excessive lending in economic upswings.

He also expressed concern about the way risks taken by financial institutions had been monitored by the authorities. "For reasons of historical accident we have created over many decades a financial system in which the incentives to monitor risk-taking have been sharply reduced."

While opposing both over-strict controls on the City and the return of banking supervision to Threadneedle Street, King said that ordinary people had been hurt as a result of the crisis resulting from losses made in the US sub-prime mortgage market. A system had to be found to ensure that banks could fail in an orderly manner, he said.

"It is often said that the role of a central bank is to take the punch bowl away just as the party is getting going. That approach has served us well in monetary policy.

"But all those efforts will come to naught 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 become wilder and wilder," he told the BBA.

"That might not matter were the consequences limited to the party-goers. But they are not. When the party ends, some innocent bystanders may lose their homes altogether."

King said that after a decade of stability, the UK was "facing a period of rising inflation and weaker growth." He added: "Part of the reason for this change of economic weather is that we are passing through the most prolonged period of financial turmoil that most of us can remember. Whether, as the IMF has argued, it is the worst period of financial stress since the 1930s is too early to judge. After all, the crisis is not over yet."

About this articleClose This article was first published on guardian.co.uk on Tuesday June 10 2008. It was last updated at 14:42 on June 10 2008.

http://www.guardian.co.uk/business/2008/jun/10/bankofenglandgovernor.creditcrunch
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