Warning to banks if their borrower collapses

Banks that make wholesale loans to other banks must be required to take a hit if their borrower collapses and must not expect to be bailed out by government, as they have been in the current crisis, Paul Tucker, Bank of England deputy governor, said yesterday.

Mr Tucker spelt out various regulatory measures needed for the oversight of complex international financial institutions that stop short of requiring a breakup of "too big to fail" banks .

"A thread that runs through the discussion is how to preserve the core financial services provided to the economy through periods of extreme stress without bailing out banks' equity holders or uninsured wholesale creditors," Mr Tucker said in remarks prepared for a European banking conference in Brussels.

While banks' managements might not consciously take undue risk, wholesale funds might be so cheap and available that they were tempted to borrow them for risky pursuits with higher returns than the cost of funds, he said.

In the financial crisis, some bank shareholders were wiped out or forced to take big losses. But wholesale creditors, such as those who bought bank debt, had not been nearly as damaged because governments intervened. Without tougher regulation, the balance of risk would continue to fall on taxpayers, said Mr Tucker.

To minimise the need for banks to use central bank facilities they should be required, as the Financial Services Authority has proposed, to hold "inalienably liquid" instruments, such as UK government gilts.

He noted that the Bank of England was to consider accepting as collateral a wider range of loans, including portfolios of loans to companies and households, and of equities.

The Bank has been criticised for not doing enough to stimulate lending to households and smaller enterprises. Accepting these loans as collateral for cash loans could free up funds for lending to businesses. *Banks should pay an annual 10 per cent profits tax in exchange for the taxpayer support they have received, Vince Cable, Liberal Democrat Treasury spokesman, said on the BBC last night. He said the tax could raise about £2bn a year and be used to pay down the structural deficit.