STRICTER regulation of banks' lending is needed to ensure there is no repeat of the "credit bubble" that led to the current global economic crisis, the deputy governor of the Bank of England said last night.
Sir John Gieve's startling admission of the failure to control debt was made on the BBC's Panorama programme. He said the Bank had spotted "some crazy borrowing" and conceded it had been caught by surprise by the extent of the downturn and the impact the £1.4 trillion credit bubble would have on the economy.
The scale of the crisis that led to the government bail-out of institutions such as RBS and HBOS was underlined by Alistair Darling, the Chancellor, who said the financial system "came perilously close to collapse".
RBS received £20 billion, and HBOS and Lloyds TSB are set to receive £17 billion, with the largest part going into HBOS.
Sir John called for the Bank to be given new tools beyond the "blunt instrument" of interest-rate-setting to stave off a future banking crisis.
"We need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks," he said. "Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand."
The banking system must never again be allowed to come "so perilously close to collapse", said Mr Darling.
"RBS needed an awful lot of capital," he said. "It's one of the biggest banks in the world, and we now own 57 per cent of it.
"I was very clear that banks had to have a choice. They could go to the markets and raise the money. But we were also clear that two banks in particular, RBS and HBOS, were not going to be able to raise money in the markets and the only place to come to was the government. I was very clear even before the turbulence of that week that, whatever we did, we had to do it for the entire banking system."
Mr Darling described rescue talks with bankers that took place on the Sunday night and Monday morning of the week in question.
"I had meetings all day on the Sunday and then, at 10pm, just when everything was agreed as far as I was concerned, inevitably when you deal with a bunch of bankers, they started trying to reopen it.
"So I said at about 1am, 'OK reopen it if you want. I'm going to my bed. If you haven't agreed it by five o'clock, then you're on your own'. So happily when I woke up at five o'clock, we'd got an agreement."
Sir John echoed the Chancellor's view, saying that Britain's banking system came "right to the brink". "Several of our large banks, and I don't want to go into names, were in real difficulty and were having – hour-by-hour, minute-by-minute – to balance the books," he said.
Sir John said the Bank of England "didn't think it was going to be anything like as severe as it turned out to be".
And John Varley, Barclays' chief executive, told the programme: "It seemed increasingly likely as the week went on that one or two of the British banks would not be capable of opening for business the following week, and it doesn't get more extreme than that."
John Letizia, the head of government relations for the British Bankers' Association, said the industry would consider more regulation over debt levels and how much banks could lend.
Banks would welcome a debate about further rules "but we need to ensure the safeguarding of capital does not impede banks' ability to innovate and compete", he said.
Sir John also warned that taxpayers could lose out because of defaults in mortgages held by nationalised banks. "There are some books – Northern Rock, Bradford & Bingley – which clearly have a level of defaults in them," he said.
On the question of interest rates, Sir John said raising them would not have held back surging house prices. "We would have been holding down the level of activity elsewhere in the economy, in manufacturing, in other services, holding down the level of employment at a time when consumer price inflation and earnings were stable and reasonably low," he said.
Economists have blamed low interest rates for fuelling the demand for credit, both in the UK and the United States.
Sir John said the period of growth before this year's crash had not resembled previous boom-and-bust cycles, lacking the typical big increases in earnings, consumption and activity.
"We saw the credit, we saw the house prices, but we did see a fairly stable pattern of earnings, prices and output," he said.
Sir John, who is a member of the Bank's monetary policy committee (MPC), whose job it is to set interest rates, will leave his post next year. He has specific responsibility for financial stability.
Yesterday, the pound took a further slide on the currency markets, as traders took Sir John's comments as a sign the Bank wanted further interest rate cuts in the new year.
Rate cuts tend to weaken demand for a country's currency by reducing the yield on interest-bearing investments.
The Bank has cut its interest rate three times since October, bringing it down by a total of three percentage points to a mere 2 per cent – a 57-year low.
Gordon Brown, the Prime Minister, laid the blame for the global financial crisis on a reckless banking system. In an interview published yesterday, he said: "I'm angry – angry we had a banking system where people neither knew the risks they were taking nor were open enough about the problems they had."
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