King Says U.K. Banks May Need More Capital to Finance Recovery

By Svenja O’Donnell and Jennifer Ryan

June 18 (Bloomberg) -- Bank of England Governor Mervyn King said Britain’s banking system may need to raise more capital to finance the economic recovery as officials keep printing money.

“It may take further additions to equity capital before the banking system will be able to supply credit at a price and on a scale to finance a sustained recovery,” King said in a speech at the Mansion House in London yesterday. “It is too soon to reverse the extraordinary policy stimulus that has been injected into the U.K. economy through monetary policy.”

The Bank of England plans to spend 125 billion pounds ($204 billion) of new money on assets to kick-start economic growth, and Gordon Brown’s government has propped up some of the nation’s biggest banks with taxpayer funds. King, speaking alongside finance minister Alistair Darling, said both monetary and fiscal policy will have to change as the economy stabilizes.

“When appropriate the Monetary Policy Committee will raise bank rate” from the current 0.5 percent “and gradually run down its portfolio of assets in a manner consistent with maintaining orderly markets,” King said. “It is also necessary to produce a clear plan to show how prospective deficits will be reduced during the next Parliament.”

Dividing lines for the next election, which must be held within a year, sharpened this month. The opposition Conservatives have accused Brown of misleading voters after the prime minister denied most ministries face deep spending cuts. A mix of spending restraint and tax increases is inevitable, whichever party takes office, economists say.

‘Tough Choices’

“Support for the economy now must be matched by action to ensure we live within our means,” Darling said in his speech. “There are tough choices ahead. I will continue to do whatever is necessary to ensure sustainable public finances.”

The government has nationalized banks and invested billions of pounds in Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc. U.K. banks have already raised $158 billion in capital to shore up their balance sheets, Bloomberg data show.

While the current crisis still has “some way to run” and banks have more work to do in reducing leverage, investors have continued to perceive greater risk in the industry, King said.

“Put bluntly, market data on credit spreads imply that some banks are viewed as a worse credit risk than some of their customers,” he said. “Companies that can bypass the banks to access capital markets directly are doing so.”

Investors are demanding extra returns to hold bonds issued by banks. The spread between the yields of sterling-denominated bonds issued by financial companies and benchmark government debt averages 619 basis points, according to Merrill Lynch & Co. data. That compares to an average spread of 289 basis points for non-financial companies. A basis point is 0.01 percentage point.

Money Supply

King said there are “tentative signs” the central bank’s asset purchase program is starting to work as money supply is “picking up.” Policy makers this month reiterated their plan to keep buying government and corporate bonds.

While full economic recovery may be “protracted,” King said “there are some signs that the British economy is beginning to stabilize, and financial markets have improved markedly.”

The British Chambers of Commerce today cut its forecast for U.K. economic growth, saying the outlook “remains very precarious.” Gross domestic product will shrink 3.8 percent this year, compared with a forecast in March for a contraction of 2.8 percent, the BCC said. Unemployment will rise to a peak of 3.2 million in the second half of next year, the group said.

King said new regulation on the banking sector should eliminate an implicit state guarantee for firms that combine household services with risky investment banking or funding strategies. He suggested banks which pose greater risks to taxpayers should face higher capital requirements or be prevented from offering services to consumers.

Any regulated bank should also be required to produce a plan for it to be wound down in the event of failure.

“Making a will should be as much a part of good housekeeping for banks as it is for the rest of us,” he said.

To contact the reporters on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net; Jennifer Ryan in London at jryan13@bloomberg.net.