King Leaves Unfinished Business for Carney to Repair U.K. Banks

Bank of England Governor Mervyn King said his successor and the U.K. banking industry have “unfinished business” to do in reforming the financial system and reviving the U.K. economy.

“The future of banking will depend not only on changes to leverage but also on a greater degree of responsibility by all involved: the leaders of our banks, regulators and consumers,” King said in his annual Mansion House speech in London late yesterday. “We must restore trust in our banking system.”

King’s final address to finance industry leaders before Mark Carney succeeds him on July 1 accompanied a speech by Chancellor of the Exchequer George Osborne, who said that the economy is “healing” and pledged to privatize Lloyds Banking Group Plc and consider a “bad bank” as part of a breakup of state-owned Royal Bank of Scotland Group Plc. King backed the plans, and said that leverage at banks remains too high.

“It is difficult to imagine a banking sector like that making a real contribution to any economic recovery,” King said. “It must be time for decisive action.”

He said an example of such action is the Prudential Regulatory Authority’s review of bank capital needs, which have shown a shortfall of about 25 billion pounds ($39 billion) relative to levels recommended by the Financial Policy Committee. The PRA’s assessment of capital requirements for the biggest banks will be published at 7:00 a.m. in London today.

Some Way

“It is too soon to say the job is done” given lenders’ leverage levels, he said. “There is clearly some way to go before we can claim to have a really well-capitalized banking system.”

Officials must “deal once and for all” with the problem of banks that are too big to fail, King said. The Independent Commission on Banking’s recommendations for a ring fence between investment and commercial banking and a leverage ratio must be put in place “as soon as possible.”

To ensure banks continue to lend, King also announced that the BOE will expand its system for providing them with liquidity by expanding the pool of collateral for auctions and making its discount window cheaper and easier to access.

There are “clear signs that a recovery in the U.K., albeit modest, is under way,” though “growth is not yet strong enough to reduce the considerable margin of spare capacity in the economy,” he said. “The weakness of the euro area and the problems of the U.K. banking system continue to act as a drag on growth. So the need to support the recovery remains.”

King’s Vote

Minutes of King’s final Monetary Policy Committee meeting published yesterday show he was defeated for a fifth month in his bid to expand bond purchases by 25 billion pounds. A six-member majority opted to hold the bond plan at 375 billion pounds, citing inflation risks and signs of recovery.

While inflation has held above the central bank’s 2 percent since December 2009, and the latest data show it accelerated to 2.7 percent in May, King said the outlook is for it to return to the goal amid low pay rises and underlying pressure. “Inflation targeting achieved its objective,” he said.

“The greater risk at present is that, over the next few years, unemployment remains unnecessarily high,” he said. “It is too soon to say that the job of securing recovery is complete. There is a powerful case for more stimulus in the short run.”

It’s also too soon to unwind policy that’s produced “unsustainably low” interest rates, he said. The bank has held its key interest rate at a record low of 0.5 percent since March 2009. A recent jump in bond yields shouldn’t be confused with a “return to normality,” King said.

“A rapid return to higher interest rates would do great damage to the balance sheets of highly indebted households, companies and, especially, financial institutions,” he said. Still, “the real challenge -- on a global scale -- is to rebalance the world economy. A failure to deal with global imbalances will not only retard the recovery as a whole, but worsen the scale of the adjustment ultimately needed. It will inevitably be a bumpy ride.”

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