Mervyn King, the governor of the Bank of England has predicted that the UK is "passing through the most prolonged period of financial turmoil that most of us can remember" and warned that "the crisis is not yet over".
It is too early to judge, he said, whether or not the current global economy is facing the worst period of financial crisis since the 1930s, but admitted that the economy faces a period of rising inflation and weaker growth.
Addressing the British Bankers' Association (BBA) at a conference yesterday, he explained that financial stability needs to be regulated in a similar way to how the Monetary Policy Committee (MPC) decides on the base rate decision each month.
But, he also said that it "would not be right for the Bank to take back banking supervision from the FSA", which took on the supervisory role in 1997, but that there is room for improvement in the relationship between banks and their regulators.
Mr King also said he should be given more powers to reign in market turmoil, and that banks should be given room to fail without it resulting in catastrophe.
The governor pointed to the success of the Special Liquidity Scheme as an example of where "the close cooperation" between the Bank of England
and the banks resulted in "effective collaboration". He also said that he plans to keep liquidity in the banking system flowing, outlining plans to create a permanent facility for banks facing liquidity issues.
The Bank blamed the banking industry for disregarding risk-taking policy and causing thousands of people to lose their homes with reckless lending. "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." he said.
"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."
The proposed liquidity plan – which would see banks paying into a contingency fund to protect against liquidity shortages – and a guarantee on savings deposits mean that future runs on banks, such as that experienced by Northern Rock last summer, will hopefully be avoided.
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