BoE: No bank too big to fail

London - The Bank of England warned on Friday that Britain's banks are far from getting a clean bill of health despite signs of improvement in the economy and in financial markets - and said that no bank should be too big to fail.

In its half-yearly assessment of the stability of the financial sector, the Bank of England said the banks have to change their ways not just now but when recovery inevitably comes. It said regulation must be tighter to prevent a repeat of the crisis that sent the British economy into a deep recession.

The Bank of England said the commercial banks should set up contingency plans to deal with potential problems, not least in how they wind up complex trading positions, and that the domestic and international regulatory authorities should be more involved in making sure that problem positions do not pose a risk to the overall system.

The banks should also look at ways to bolster their capital positions by raising more equity, and should scale back the range of their affiliates to put an end to the so-called "too big to fail" syndrome.

The Bank of England said "simpler, more transparent, legal structures that are capable of being supervised and resolved" and "potential changes to the structure or size of banks to ensure they can be effectively supervised and wound up" should be the central in the reform of the financial system.

It was the complexity of US investment bank Lehman Brothers' dealmaking that partially proved its undoing last September, and set in train a sequence of events that nearly brought the global financial system to the point of collapse. In Britain, that necessitated massive government intervention, including stake purchases in the likes of Royal Bank of Scotland in Britain.

Banks remain sensitive

Nevertheless, the Bank of England conceded that a further shock to the system remains a possibility, especially as banks remain highly indebted at a time when funding pressures remain.

"So banks in the UK and internationally remain sensitive to further adverse economic or financial sector developments, which could in turn affect economic recovery and flow back to the banking system," it said.

The Bank of England's latest assessment of financial conditions comes just a couple of days after its governor Mervyn King shocked lawmakers by telling them he had not been consulted about the government's banking reforms, which are expected to be set out next week in a so-called white paper.

"I have not been consulted on what will be in the White Paper and I haven't seen a draft of it but no doubt at some point I will," he said.

King appeared to downplay the bank's stability report by suggesting it only described the risks, with the bank not having additional powers to enforce solutions. Under the current regulatory regime, the Financial Services Authority is responsible for monitoring banks.

"All we can do at present, before a bank is deemed by the FSA to have failed, is to write our Financial Stability Report and give speeches. If you're content with that, that's fine by me. What you can't do is turn around afterwards and say 'You have the statutory responsibility, why didn't you do something?' when there is nothing we can actually," King said.

- AP