King warns Europe not to weaken bank capital rules

Governor says letting banks run dangerously low buffers was 'tragic' error

The Governor of the Bank of England last night warned European officials not to water down new bank safety rules or prevent the UK from imposing tougher measures to protect taxpayers.

In his Mansion House speech, Mervyn King told the City's elite that all systemically important banks must hold more common equity capital to absorb losses in future crises – as set out in last year's Basel III agreement.

The soon-to-be-knighted Mr King said: "A crucial part of the new Basel III framework is the recognition that only common equity is ultimately a truly loss-absorbing layer of capital. I am therefore concerned that the European Commission will propose a weakening of the Basel standards in that area."

Britain, Spain and five other countries last month wrote to Michel Barnier, the European internal market commissioner, objecting to lobbying for national variations on the levels of core capital required under Basel III.

France and Germany have led claims that the rules could hamper economic growth and handicap European banks compared with those in the US.

Mr King said not only should the rules on capital minimums apply across the board but that national governments should be free to impose extra measures to rein in reckless lending.

"The Basel framework was agreed globally after long and difficult negotiations at the request of the G20. It sets minimum, not maximum, capital requirements and it envisages the use of counter-cyclical capital buffers set by national regulators."

Mr King reinforced his argument by referring to remarks by Tim Geithner, the US Treasury Secretary, who said the effects of Britain's loose regulation before the crisis were "tragic".

He said the tragic error was "the mistaken belief that by compromising on unduly low capital requirements and inadequate limits on leverage, regulators can compensate by a detailed oversight of every aspect of a bank's activities."

The Governor pledged that when bank supervision moves to the Bank of England, its Financial Policy Committee would monitor what is going on in the overall banking system to spot growing risks.

The Governor also defended the Bank's record on interest rates and warned that the UK faced several more years before its reliance on debt was put right. The Bank's Monetary Policy Committee (MPC) has kept interest rates at a record low of 0.5 per cent for more than two years but is under pressure to increase rates to combat inflation.

Mr King said that if the MPC had increased rates before now, it would have increased unemployment, weakened the recovery or sent the UK back into recession. "The mix of tight fiscal and loose monetary policy is necessary for a rebalancing of the economy," he said.

He added that rates would need to rise to more normal levels "at some point" but that there was little sign of domestically generated inflation so far.