Page last updated at 15:29 GMT, Tuesday, 29 April 2008 16:29 UK

Governor attacks City risk-taking

Mervyn King says ''a lot of lessons'' have been learned

The governor of the Bank of England, Mervyn King, has criticised City banks who reward staff with huge sums for taking risks.

He told MPs on the Treasury Committee that the credit crisis was caused by bankers betting on high-risk complex financial products.

Mr King criticised their managers, who he said did not understand the complicated instruments.

They would have to do better if they wanted to keep their jobs, he said.

The governor, who faced criticism for the Bank of England's response to the credit crisis and the collapse of Northern Rock, said managers awarded bonuses that encouraged risk-taking.

Their pay structures were too closely linked to the short-term results of investments rather than long-term results.

I think all of us - and I do not exclude the Bank in this - have learnt a lot of lessons from the last nine months
Mervyn King, Bank of England governor

"Banks have come to realise they are paying the price for having designed compensation packages that provide incentives that are not in the long-run interests of the banks themselves."

Mr King said the risky financial instruments were "based on some very poor assumptions".

Many of the world's largest banks have lost large amounts on these complex financial products, whose design meant investors underestimated or misunderstood the risks involved.

He said those banks which decided not to invest in these instruments - which were being described as "innovative, exciting activities," - were "often pilloried for being boring".

"We must make sure it doesn't happen again," Mr King said.

"I think all of us - and I do not exclude the Bank in this - have learnt a lot of lessons from the last nine months," the governor said.

Restoring confidence

Earlier this month, the Bank of England announced a plan to enable banks to swap potentially risky mortgage debts for secure government bonds in order to relieve a credit squeeze.

Mr King said the most recent crisis was not down to a lack of funds in the market - so-called liquidity - but was a result of a lack of confidence that meant banks were unwilling to lend to each other.

As a result, banks have been restricting lending to homeowners.

But the governor was keen to stress that the Bank of England's plan to loan 50bn was not a 'bail-out' of the banks and was not designed to stimulate mortgage lending.

Mr King said it would be a mistake to go back to where the mortgage market was a year ago, when loans were cheaper and easier to get.

However, despite not being the target for the loan scheme, Mr King said that if successful, homeowners should benefit from the scheme down the line.

"There is the need for an adjustment in the mortgage market," he said.

"But I do think the improved confidence in the banking sector, which I think this scheme will eventually restore, will feed through to borrowers and we'll see the mortgage market operating on a more normal basis."

Defending himself against an accusation from George Mudie MP that he lacked sympathy for struggling homeowners, the governor said,

"I am not in favour of attaching political objectives to central bank operations," Mr King said.

Mortgage costs

Mr King had to field questions about whether the main measure of inflation, CPI, which the Monetary Policy Committee uses as a target for setting interest rates, accurately reflected the rising housing costs faced by homeowners.

Mr King said he said a change in how CPI was measured would be "desirable".

"I would like to see CPI include house prices in some form," he told the committee of MPs.

The measure does not currently include mortgage costs, but does include rental prices.

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