Credit crisis caused by 'inability' to regulate 'dangerous' banks

18 March 2009 / by Rachael Stiles
Bank of England governor Mervyn King has spoken of an "inability to perceive the true nature of the risks involved" which led to the current financial crisis.

In a speech to the Worshipful Company of International Bankers on Tuesday evening, he implied that the credit crisis and recession which was to follow was inevitable.

"Perhaps we had forgotten that such panics and banking crises have occurred with depressing regularity in the financial systems of market economies," he said.

Later, he accused banks of being "dangerous institutions," which "borrow short and lend long. They create liabilities which promise to be liquid and hold few liquid assets themselves."

But, in a jibe to the Prime Minister and Financial Services Authority, he suggested that the full extent of the crisis could have been averted with better regulation.

The "extraordinarily sudden, severe and simultaneous downturn of activity and trade in every corner of the world economy" which occurred last year was "remarkable," he said, even against the backdrop of previous cyclical banking crises.

"A collapse of confidence in the coffee houses of Lombard Street was one thing; a collapse of confidence in the world economy is quite another," Mr King remarked.

Henceforth, the system should be redesigned in an image of "constrained discretion," he believes, which addresses the weaknesses in the financial system. But, he explained that considering how the excessive risk-taking of recent years has now resulted in an about turn – "an extraordinary degree of risk aversion" – there is no rush to choose a new system.

"Whatever exuberance – rational or irrational – existed has been destroyed by the crisis," he said. "So we have time to reflect before we decide on the shape of a new regulatory system."

BBC economics editor Stephanie Flanders said that "the bottom line is that if we want to avoid the next bust we have to be prepared to pass up the boom," but she doubts that this is a likely scenario.

The governor's plans for "simple and robust" policy tools and a system of "constrained discretion" will go some way towards diverting future crises, she said, "but down the road, when memories of 2008 have faded, it is hard to believe they will be enough."

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