‘A painful adjustment faces the global banking sector over the next few months as losses are revealed and new capital is raised to repair bank balance sheets,’ Bank of England governor Mervyn King warned yesterday.
Answering questions from MPs on the House of Commons Treasury committee on the Northern Rock crisis, he also warned that ‘a run on a bank is always a knife-edge’.
As he was giving evidence, it emerged that the Treasury had extended financial guarantees to Northern Rock at the request of the troubled lender.
Putting more taxpayers’ money at risk, the government offered to cover any loss by financial institutions which provide money to Northern Rock so the bank can operate normal banking services.
This is on top of guaranteeing savers’ deposits held at Northern Rock, after September saw the UK’s first run on a bank in living memory.
According to King, the additional guarantees amount to 30 per cent of the Northern Rock’s balance sheet.
He said: ‘This was a natural extension to help the company. What is important now is to find a new management to take the bank forward.’
In his remarks to MPs, he tried to play down the importance of capital assets.
He said of the situation in September: ‘Here was a bank which adopted the Basel Two method of capital regulation and as a result found that it had one of the highest capital ratios of any bank in the UK, proposed to return that to shareholders, and yet it was in a very vulnerable liquidity position.
‘That shows if anything does, that capital is not all.’
However, he admitted: It does mean that in parallel with it you do need a proper regime of regulation of liquidity.’
Meanwhile, the Bank of England loaned another £10bn to banks and financial institutions in a bid to ease the impact of a credit crunch and high borrowing costs.
The central bank allowed banks to bid for the cash at auction with 75 per cent of bids allotted at the lowest rate, 5.36 per cent, below the central bank’s official rate of 5.5 per cent.
The highest accepted rate was 6.6 per cent, giving a weighted average rate of 5.949 per cent, the Bank of England said.
The aim of the cash auction was to cut the interbank lending rate.
On the Continent, the European Central Bank took the unprecedented measure of allocating 348.67bn euros ($502bn; £249bn) to banks at a below-market rate in a refinancing move to ease tightened credit markets and avoid a crisis over the Christmas period.
All banks with enough collateral, and which submitted bids of at least 4.21 per cent, received funds from the ECB.