Credit crisis cost the nation £7trn, says Bank of England

Bank director criticises current regulation and calls for structural reform

Economics Editor,Sean O'Grady
Wednesday 31 March 2010 00:00 BST

The financial crisis has cost the British economy up to £7.4trillion in lost output, according to the Bank of England.

Andrew Haldane, the Bank's executive director for financial stability, said that taking into account the permanent damage done to the productive potential of nations across the world, as well as the immediate costs of supporting the banks and the recession, there is an output loss equivalent to between $60trn and $200trn for the world economy and between £1.8trn and £7.4trn for the UK.

He put the hidden cost to the taxpayer of the implicit support offered to the big UK banks at more than £50bn.

Mr Haldane advocated new structural controls on the banks, a policy at odds with the current views of Lord Turner, chairman of the Financial Services Authority, and the Treasury.

Mr Haldane drew a contrast between the "taxation" solution – making risky banking more expensive by raising capital requirements, an idea favoured by the FSA and the Government – and the "prohibition solution", backed by the Bank and the Obama administration in the US. Prohibition means the separation of bank activities across business lines.

Referring to the most famous piece of legislation that broke up the banks, Mr Haldane drew a positive comparison between the US Glass-Steagall Act of 1933 and the modern Basel II international capital regime. He said: "Glass-Steagall was simple in its objectives and execution. The Act itself was only 17 pages long... lasting well over half a century without a significant systemic event in the US. The contrast with Basel II is striking. This was anything but simple, comprising many thousands of pages and taking 15 years to deliver... [and was]... overwhelmed by the recent crisis scarcely after it had been introduced."

Mr Haldane, echoing the Bank's Governor, Mervyn King, dismissed claims made about the importance of economies of scale. He said the experience of the crisis was that larger, more diversified banks had suffered "proportionally greater losses".

He added: "Limits on the optimal size and scope of firms may be as much neurological as technological... this crisis has provided many examples of failures rooted in an exaggerated sense of knowledge and control. Risks and counterparty relationships outstripped banks' ability to manage them."

The Bank is calling for reforms in line with Liberal Democrat and Conservative proposals, in opposition to government policy. The Chancellor, Alistair Darling, this week again stressed the need for a co-ordinated G20 approach to "too big to fail".

In a final assault on the FSA, Mr Haldane concluded: "It is possible that no amount of capital or liquidity may ever be quite enough. Profit incentives may place risk one step beyond regulation. That means banking reform may need to look beyond regulation to the underlying structure of finance."

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