King's stark warning to banks: we won't step in if risk goes wrong

Published on Tuesday 10 June 2008 21:05

MERVYN King yesterday warned Britain's banks that they could no longer count on the Bank of England coming to their rescue if they founder on the back of ever-more risky quests for profit.

The Governor of the Bank's hard-hitting intervention came as Stephen Green, the chairman of HSBC, declared "the end" of the high leverage business model for banks.

The blunt dual warnings were delivered at the annual meeting of the British Bankers' Association in London yesterday.

Using unusually colourful language, King spelled out the Bank's tough approach in the wake of the credit crunch and the collapse of Northern Rock.

The Governor said the financial system was going through "the most prolonged period of financial turmoil that most of us can remember" before adding: "The crisis is not yet over."

He singled out the way some financial institutions had become incentivised to take on risks that could cause "significant damage to the rest of the economy... Because the authorities will face an incentive to step in to rescue banks tomorrow, there is an incentive for banks to take more risk today".

King said that incentives to monitor risk-taking have been sharply reduced over many decades.

He added: "It is often said that the role of a central banker is to take the punch bowl away just as the party is getting going. 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."

His remarks will be seen as a direct attack on the aggressive lending culture led by the likes of Citigroup chief executive Charles "Chuck" Price and followed by some in the UK. Just before the global credit crisis last August, Price boldly declared: "As long as the music is playing, you've got to get up and dance. We're still dancing".

King's remarks were underlined by comments from Green, one of the UK's most respected bankers.

He told the conference that the industry needed to get "back to basics" – focusing on attracting retail deposits instead of excessive borrowing to fund business growth and he

added: "We are seeing a profound shift in banking models.

"The huge build-up of leverage in the system in the last five years … which stretched balance sheets, and with profits dependent on high and increased leverage ... that model has gone.

"It is not just the end of a bubble, it's the end of a business model."