The UK's mountain of debt could leave the country powerless to launch another rescue bid in the wake of a fresh financial crisis, the world's central bankers warned yesterday.
Their "club" - the Bank of International Settlements - presented in its annual report a frightening picture of the impact of a second banking emergency on heavily indebted nations such as Britain.
The Bank of England's Governor, Mervyn King, has estimated that the Government has pumped as much as £1trillion of taxpayers' money into the banking system. Billions of pounds were spentpart-nationalising the Royal Bank of Scotland and Lloyds Banking Group, as well as fully nationalising Northern Rock, in an attempt to stave off collapse. Measures such as the "special liquidity" scheme propped up other lenders and prevented the system from freezing up.
But a BIS report warned yesterday that repeating these measures could be impossible. It said: "Events coming out of Greece highlight the possibility that highly indebted governments may not be able to act as a buyer of last resort to save banks in a crisis. That is, in late 2008 and early 2009, governments provided the backstop when banks began to fail. But if the debts of the government itself become unmarketable, any future bailout of the banking systemwould have to rely on external help." Central bankers fear Europe is running out of "external backstops" that could step in, other than the US and the International Monetary Fund. This has unnerved capital markets in the EU, prompting some sharp swings in the value of shares and other financial instruments in recent days.
The BIS has previously said that the ultimate calamity - payments systems freezing and cash machines running out of money - was only narrowly avoided when the US investment bank Lehman Brothers collapsed in 2008. A deeper economic slump was averted by nationalising other banks and making loans amounting to $10trn (£6,620bn).
But the BIS report implies that governments may not be able to repeat such a bailout in the event of a second crisis, which some commentators fear could be triggered by another economic shock.
Despite the warnings, the G20 nations significantly eased the pressure on banks this week by delaying the introduction of tougher rules on the amount of capital they must hold to deal with potential crises. The new regulations were planned for the end of this year but are not now due until 2012. Countries will also be given far more leeway inhow the rules must be applied. Critics say this amounts to a watering down of the reforms needed to stave off the sort of disaster the BIS fears.
The BIS alsowarned that the "fragility" of public and private balance sheets in the UK,France, Germany, Spain and the US "severely limits the scope for fiscal policy intervention if another bailout is needed". It added: "The side effects of the financial and macro-economic supportmeasures, combined with the unresolved vulnerabilities of the financial sector,threaten to short-circuit the recovery; the reforms necessary to improve the resilience of the financial system [have] yet to be completed."
In remarks that in effect back the German and UK governments' success at the G20 over deficit reduction, the BIS argued for "immediate, front-loaded fiscal consolidation", noting that "the time has come to ask when and how these powerful measures can be phased out".
The BIS also dropped the broadest hint yet from an international body that a Greek sovereign debt default was now an accepted fact. It said: "As the long history of sovereign debt crises has shown, when investors lose their confidence in a country's ability to service its debt and become unwilling to hold it, rescue packages, bailouts and even debt restructuring remain the only options."
The BIS added that the official projections for public debt, including Britain's, underestimated the extent of the additional pressure that ageing populations will place on welfare and health spending. The BIS suggested that, if corrective actionwere not taken, the ratio of the UK's debt to gross domestic product (GDP) would rise from 70 per cent of GDP to 450 per cent by 2040 - a burden that would become "unsustainable" long before that was reached.
The 56 members of theBIS also suggested that interest rates ought to rise sooner rather than later as they were "discouraging needed reductions in leverage [debt levels], thereby adding to the distortions in the financial system and creating problems elsewhere". "Direct support" to banks, via recapitalisation and loans, was "delaying vital post-crisis adjustment", the BIS added, saying: "despite the improvement to balance sheets, several factors raise doubts about the sustainability of bank profits".
In an overwhelmingly gloomy assessment of the state of the world, the BIS also points to the risks of emerging economies overheating, and the continuing weakness of the commercial real-estate market, also highlighted recently by the Bank of England.
But dismissing fears of a "double dip" recession, the BIS argued that any initial costs of fiscal tightening would be "outweighed by the persistent benefits of lower real interest rates, greater stability of the financial system and better prospects for economic growth".