New banking code to restrict leverage

The governments of the world's largest economies have moved decisively to prevent any recurrence of the collapse of the global financial system.

The Financial Stability Forum, an umbrella body that comprises individual governments and central banks as well as international bodies such as the IMF, has proposed that, in future, banks will be prevented from borrowing – or creating "leverage" – on the scale seen in recent years, and will have to set aside more of their own resources, or capital, so that they can withstand any future turbulence. Mario Draghi, chairman of the forum and governor of the Bank of Italy, said it had taken an unprecedented financial crisis to drive home to financial institutions that they have to have "less debt, more capital". Firms have resisted because they refused to believe "profits are going to be lower in the future" in the financial sector.

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Mr Draghi's views were endorsed by the chairman of the Financial Services Authority, Adair Turner. He told a meeting of the International Institute of Finance, a group representing the world's private banks, that he foresees a "large-scale disappearance" of independent investment banks and of the type of highly leveraged "shadow" vehicles used by banks to keep assets and transactions away from public scrutiny.

The managing director of the IMF, Dominique Strauss-Kahn warned that more countries could follow Iceland into virtual national bankruptcy. He identified Estonia, Latvia and Lithuania as being especially at risk.

He said that some banks in eastern Europe had become increasingly exposed to struggling property markets, having raised funds on international money markets, as did the ill-fated Icelandic banks. These banks may be forced to reduce credit and the risk of such a scenario has risen, for instance, in the Baltic states, where house prices and credit growth have fallen, Mr Strauss-Kahn said. Unlike Iceland, Estonia, Latvia and Lithuania are full members of the European Union, and may turn to the EU for help. Argentina, Ukraine and Kazakhstan are also increasingly mentioned as especially vulnerable.