Modest restraint by the banks during the boom years over bumper bonuses and dividends would have spared taxpayers the cost of recapitalising them during the financial crisis, the Bank of England says.
It also highlights the fact that more than £1trillion of funding will have to be found by lenders to finance their activities over the next few years, with no evidence that the Bank is enthusiastic about extending its current unprecedented support.
Such a removal of support, the Bank suggests, could lead to a serious correction to gilt and equity prices. "The enormous scale of public sector intervention means that any withdrawal of policy support could have a significant impact on investors' portfolio choices and relative asset prices, including government securities," it warns.
"Valuations in some financial markets are vulnerable to such a reappraisal. For example, an increase of one percentage point in long-term real interest rates or UK equity risk premia would be consistent with a fall in equity prices in the UK of around 16 per cent."
In its latest Financial Stability Report, the Bank goes on to tell the banks that they "could usefully take advantage of currently favourable conditions through issuance in private markets and retention of profits to build capital".
In a clear hint that the Bank would prefer banks to retain profits rather than distributing them to investors or staff, it adds: "If discretionary distributions had been 20 per cent lower per year between 2000 and 2008, banks would have generated around £75bn of additional capital – more than that provided by the public sector during the crisis."
The Bank warns that commercial banks will need to raise up to £33bn more in new capital, saying: "Capital buffers will need to rise, possibly substantially, over the coming years."
The banks are urged to take opportunistic advantage of currently buoyant capital markets. Lloyds Banking Group recently completed the largest-ever rights issue. Some £50bn of equity has been raised by the big banks recently, improving their capital ratios by two percentage points.
A number of other risks to financial stability concern officials, including the depressed state of the commercial property market and some indirect damage that could arrive from "pockets" of trouble in European banks exposed to losses in eastern Europe.
However, the Bank also points to more hopeful signs. The destruction of financial wealth as a result of the crisis is now down to $6.3trn (£3.9trn), against peak losses of $24.3trn (£15trn) at the height of the credit crunch.
In a further push in the direction of "narrow" banking, the report also discusses ways that core banking functions can be separated from the other activities of banks, with separation of function existing within a confederal legal structure. Such insulation of payments systems and basic banking is said to be akin to the way utilities are regulated.
The Bank's discussion of such options comes as the powerful Basel Committee of central bankers and regulators proposes tougher capital requirements, and seems less keen than was previously assumed to allow "hybrid" or "contingent capital" – bonds that can be converted into equity in times of stress – to be allowed to count towards an institution's core capital. Many banks issued such paper on the assumption it would count as core capital. The Basel Committee also said banks ought not to be able to use past losses to offset against tax. Bank shares fell sharply on the news.
Fundamentally, though, neither the Bank report nor the Basel proposals offer an early end to the current situation, where every bank in the world of any size is operating with an implicit taxpayer guarantee, and benefiting from direct and indirect public support of perhaps $5trn (£3trn) globally.