The UK financial sector sails on in a thick fog of uncertainty. Investors have repeatedly struck icebergs surfacing around them. Last week, analysts were stunned by the scale of HBOS’s losses – £10bn in 2008. Although the UK government has plans for clearing the gloom in the medium term, it must do something so the system can function in the meantime. The UK needs a robust banking system; it is vital for the broader economy.

The government, last month, announced a plan to deal with the toxic assets held by UK banks. After an appraisal, the Treasury will absorb some – or all – of the risk attached to these assets either with an insurance scheme or with a “bad bank”. This should dispel some of the disquiet around the sector. The solution, however, will take months to assess, price and work through. As with the US, doubts remain about which banks will take part.

In the meantime, investors need the confidence to lend through the banking system so that whatever reasonable demands for credit exist can be met. This cannot be allowed to wait until the plan is in place. Funders must not fear their investments are imperilled by their banks extending new lines of credit to customers. Otherwise, institutions will have incentives to be overcautious.

The UK government, in common with those of other big countries, has already pledged that it will not allow British banks to fail and thereby renege on their bondholders. Having made this commitment in communiqués and speeches, however, the government should formalise it, pledging to recapitalise any bank whose capital ratio falls below a specified floor.

The sector is already sliding towards greater public ownership. Alongside the existing implicit commitments to shore up the banks with new capital, the fees paid by banks to the Treasury for taking the risk of toxic assets may well be paid in bank equity. But the banks are not enjoying the benefits in terms of confidence that this Treasury support merits. If the public is to absorb bank risk, the banks should not be eyed with suspicion.

The UK Treasury has more power to make such promises than most finance ministries. It must be careful to keep an eye on the vast risks it is taking on from the UK’s skeleton crew of bankers in overseas markets. In the US, by contrast, the problem is the Treasury’s reluctance to do enough. The government there hopes to resolve the crisis by simply using up the cash left over from the troubled asset relief programme. They will need more money, or else they risk leaving their banks adrift in the mist.

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