Mervyn King wants to limit the size of banks in the future
The Bank of England says conditions in the financial system are easing, although the banking system is fragile and vulnerable to disruption.
In its Financial Stability Report, it said the total losses from the financial crisis reached $15tn (£10tn).
However, that is a substantial improvement from March's estimate of a $25tn fall in the value of such assets.
The Bank also calls for further regulation to prevent banks getting too big and tougher controls on lending.
Prevention and cure
With the debate now shifting on how to prevent future financial crises, Paul Tucker, the deputy governor for financial stability said: "The policy debate now underway matters enormously if we are to achieve a more stable financial system in the future."
Recent statements by Governor Mervyn King have highlighted differences between the Bank of England, the Treasury and the Financial Services Authority (FSA) about how to regulate the banks in the future.
Mr King would like the Bank of England to have a larger role in any future regulation, and in the Financial Stability Report the Bank sets out its stall.
It would like to see:
- Strengthened market discipline: Greater disclosure by banks backed by a credible threat that the government will close failing banks
- Greater self-insurance: Banks required to hold more capital and liquidity reserves, including putting extra money aside in good times
- Improved management of risk within the financial system as a whole, not just of individual banks
- Size and structure of banks to be limited
- Clear principles of public support, avoiding future moral hazard, which encourages banks to take more risks because they know they will be bailed out
In some of its conclusions, the Bank still seems at odds with the chancellor, who for example, is not in favour of limiting the size of banks.
And although the Bank of England is in broad agreement with the FSA on many of these principles, there is a dispute over who should be the lead enforcer.
Mr King said earlier this month that he did not just want to preach "sermons" to the banks without having the power to enforce them, and he appears to have won the backing of the Conservatives in his bid for a more central role.
The Bank says that the unprecedented policy action by governments and central banks had prevented disaster when "the financial system came close to collapse in the autumn of 2008, following the collapse of Lehman Brothers".
Banking crisis is easing
Banks will still face funding problems in future
Banks will need bigger reserves
Government should consider limiting size of banks
But the consequence was that the banking system received some $14 trillion in support or guarantees by central banks in the US and Europe, equivalent to half of their GDP.
Almost half of the world's largest 20 banks received direct government investment, and central banking lending to the economy more than doubled.
And although losses are less now than they were in March, the world financial system has taken a huge knock.
Losses at major UK banks soared from £150bn to £400bn between October and December, and have outpaced bank attempts to raise additional capital of around £100bn.
However, in recent months the Bank says that "sentiment has improved", with stock markets recovering some 25% to 35%.
Key bond markets have also recovered, with losses on residential mortgage backed securities (RMBS) -the key instrument that hit banking balance sheets - now estimated at $1.3tn compared with $1.8tn, and total losses on all debt instruments down $4.6tn compared with $2.7tn it estimated in March.
However, the huge losses have made the banks more reluctant to lend.
The Bank of England estimates that UK banks had a "large and rising funding gap" of £800bn, half of which was backed by securitisations which will be difficult to refinance.
And they are finding it more difficult to bridge that funding gap (the difference between what they lend and the amount they get in from savers).
The Bank warns that when the emergency support it is providing expires, some banks may find it difficult to raise enough funds.
And it says the difficulty in raising money cheaply on capital markets could be made worse if the UK and other governments still have huge budget deficits, which could make the cost of borrowing more expensive for everyone.