King Says British Banks May Still Need More Capital

By John Fraher and Jennifer Ryan

Nov. 25 (Bloomberg) -- Bank of England Governor Mervyn King said U.K. financial institutions may still need more capital and the ``single most pressing challenge'' facing policy makers is to revive the flow of credit through the economy.

``We may not have come to the end of recapitalization,'' King said in testimony to lawmakers in London. ``We should not shy away from that if that proves to be necessary.''

The Bank of England and Prime Minister Gordon Brown's government are trying to revive lending and shore up economic growth with interest-rate cuts, the biggest budget giveaway since the late 1980s and a multi-billion pound bailout for the financial system. Britain is headed for its worst recession in 17 years and a Treasury report published yesterday forecasts new mortgage lending will dry up next year.

Royal Bank of Scotland Group Plc, Lloyds TSB Group Plc and HBOS Plc have taken 37 billion pounds ($56 billion) of government funds as part of a plan to stabilize the banking industry.

Bank of England Deputy Governor Charles Bean, who flanked King at the testimony, said the dysfunctional credit market means central bank rate decisions may need to be more dramatic than in ``more normal'' times.

Rate Policy

``The `bank credit'' channel in particular is impaired by the balance sheet contraction taking place in financial institutions,'' said Bean. ``In such circumstances, bank rate may need to be moved more aggressively to achieve the same impact in more normal circumstances.''

The pound fell 0.5 percent to $1.5067 after the testimony started. Against the euro, it declined 0.3 percent to 85.21 pence. The Bank of England this month cut its main rate by 1.5 percentage points to 3 percent, the lowest since 1955.

King said failing to get banks lending again could raise the risk of deflation, and stoking credit growth is ``more important than anything else at present.'' When asked whether the government should go so far as to nationalize individual banks, King replied that ``it would be a very serious error to rule out measures that may prove necessary.''

King also said the Bank of England would have to cooperate closely with the Treasury if it were forced to cut its benchmark interest rate to zero.

``At that point there needs to be a close coordination between government and central bank because monetary policy is very close to debt management,'' said King. ``But decision-making power as to what the bank would do would still rest with the Monetary Policy Committee.''

King said the financial system needs to be better controlled to prevent a repeat of the credit crisis, which was sparked last year by a collapse in the U.S. housing market.

``There is a genuine policy objective in not letting the banking sector become too big,'' said King. ``We need new policy instruments which can be used to try to stabilize the growth rate of the financial sector'' because of the ``potential damage'' it can cause for the rest of the economy.

To contact the reporters on this story: John Fraher in London at jfraher@bloomberg.net; Jennifer Ryan in London at Jryan13@bloomberg.net.