BoE Head Signals Financial Phase Change: Liquidity for Select Banks; Failure for Others
June 15, 2012 • 12:00PM

The problem with the banking system "is one of solvency" rather than liquidity, Bank of England Governor Mervyn King stated tonight at the annual Lord Mayor of the City of London's dinner at Mansion House. "Where there are debtors who cannot afford to repay, there are creditors who will not be repaid," King said. "Until losses are recognised, and reflected in balance sheets, the current problems will drag on. An honest recognition of those losses would require a major recapitalization of the European banking system."

King announced the activation of liquidity operations, and otherwise held forth on how bad it all is: Over the last five years, "the authorities around the industrialized world have thrown everything bar the kitchen sink at the problem...", which didn't work. Now we need "bolder action."

King said that "the case for a further monetary easing is growing," and announced that "the Bank and the Treasury are working together on a 'funding for lending' scheme that would provide funding to banks for an extended period of several years, at rates below current market rates."

The Bank will also activate the Extended Collateral Term Repo Facility it announced in December, under which short-term liquidity can be injected at any time, in the face of "market-wide stress of an exceptional nature" over the coming weeks. Details on this will be released Friday morning. King said, "I want to make clear that the Bank, through its discount window and other facilities, will provide banks with whatever liquidity they require given the prospect of turbulence ahead."

While promising to protect British banks, King also made it clear that the time has come to begin consolidating the banking system globally. "[B]anks must be able to fail safely," he said. "We need a resolution mechanism, both at home and abroad, that permits troubled banks to be reorganized... That means putting an end to the 'too important to fail' problem.

So, the Bank of England will provide "whatever liquidity" British banks require, while calling for banks to be liquidated elsewhere, including in the U.S. It is a recognition that the corpse of the dead global financial system is about to experience a significant downward phase-change.