Regulation: Bank of England's King wades into banking regulation debate

King, speaking last night, said of the current situation "there are only two ways in which the problem can - in logic - be solved. One is to accept that some institutions are "too important to fail" and to try to ensure that the probability of those institutions failing, and hence of the need for taxpayer support, is extremely low. The other is to find a way that institutions can fail without imposing unacceptable costs on society."

He takes the view that no institution that is "too important to fail" should be in the private sector. He points out "encouraging banks to take risks that result in large dividend and remuneration payouts when things go well and losses for the taxpayer when they don't, distorts the allocation of resources and management of risk."

King refers to two ideas - citing well known people who have taken them up but who simply got the publicity for ideas that were already in circulation: that of retail-only banks on the one hand, dealing with, in essence, current accounts only and all other sorts of banking lumped together; or at the opposite end, to separate out investment banking and leave everything else in one place.

He says that some people say such approaches would be difficult yet "it is hard to say why."

Perhaps the most telling statement in his long speech is "anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities would be thought rather unworldly. But that is where we now are."

He proposes a complex form of capital reserves and compulsory insurance to ensure the capital requirements of banks are not breached and insolvency is avoided.

It is important to realise that the Treasury is supposed to keep a hands-off approach to fiscal policy: that was at the core of Brown's 1997 reforms. Yet, Brown, both as Chancellor and as Prime Minister has been only too willing to interfere in fiscal policy.

And, as King politely pointed out, Brown's policy to save the world has saddled the UK with a rapidly escalating public debt which will take "generations" to repay. King, faced with a barrage of pre-election media statements and reputation boosting from Downing Street, told it like it is: "output is still well below and unemployment well above their levels of a year ago. To keep inflation close to the 2% target, monetary policy tries to keep a balance between demand and supply. Judging that balance, given an impaired banking sector and the likelihood of significant fiscal tightening over the next few years is particularly difficult.

"At the moment, inflation is 1.1%. Many have forgotten that only a year ago it reached 5.2%... it will pick up over the next few months reflecting higher petrol prices, recent falls in sterling and the reversal of the cut in VAT... Over the past year, money spending, which normally increases by 5% a year has fallen by 5%."

He said that the asset purchase programme is intended to inject more money directly into the economy, to put spending money back onto its "desirable trajectory."

King's words are coded: the government put us where we are; banks should be allowed to fail; the entire economy should not be put at risk to save one sector; governments should not throw money into the economy unless they know where it's going and when they are going to get it back.

Against those tests, the past 12 years have been a failure. That King points it out without saying the words is a mark of a political animal. But there is no doubt that he's sealed his fate with the current leadership. Whether their replacement, after the coming election, sees him as a steady hand on the tiller remains to be seen.