Banks are still at risk despite more than $14 trillion US dollars (£8.6 trillion) in support from taxpayers in the UK, Europe and the US, the Bank of England warned today.
The recession could wreak further havoc on bloated bank balance sheets as firms take more losses on bad loans and other assets, according to the Bank’s latest Financial Stability Report.
The Bank estimates the UK has a potential £1.26 trillion exposure from banking sector interventions to prop up the sector - equivalent to 88 per cent of the country’s annual output.
But their continued fragility will hinder a recovery, the report said.
“As long as these balance sheet vulnerabilities persist, there is a risk to the banking system from further adverse economic financial sector developments, which could in turn affect lending and economic recovery,” it said.
Banks are still struggling with a £800 billion funding gap - the difference between loans and deposits - as greater competition for retail saving deposits adds to the pressure, the report said.
They are partly meeting this funding gap by issuing debt under the £250 billion credit guarantee scheme introduced by the Government - but could have to find £500 billion from elsewhere by 2013 as various forms of public support are withdrawn.
And with the deteriorating state of the public finances - highlighted by Governor Mervyn King to MPs yesterday - further intervention could actually harm banks further as markets question the ability of Governments to pay.
"At some point public support could become less effective, as it may eventually lead to rising fiscal concerns, which could feed back to higher funding costs for banks,” the report said.
"In future, the financial system needs to be much more resilient “without the expectation of large-scale official support”, the Bank of England added.
It called for “richer and more frequent public disclosures” by banks to ensure market discipline and a “credible threat of closure” to control risk-taking.
The report said banks should be forced to use self-insurance to guard against the risk of failure, rather than relying on implicit state guarantees.
They should also have to build up high-quality buffers during periods of strong earnings to cushion losses in times of stress - in addition to existing minimum capital requirements, it added.
The report called for banks not to become “too big or complex”, either through imposing higher capital requirements to prevent excessive growth or limiting them to relatively low-risk activities.
PA