Banks must prepare for further shocks, warns BoE's Financial Policy Committee - Telegraph.co.uk

"For example, at the present time, some actions taken to raise capital or liquidity ratios could potentially worsen the feedback loop between the financial sector and the wider economy and so should be avoided."

The FPC is a key plank of the Government's reform of financial regulation. While the Monetary Policy Committee (MPC) sets interest rates, the FPC's mandate is to prevent another financial crisis. The interim committee was set up in February, but will not gain statutory powers until next year – when its recommendations could become binding.

Simon Hayes, UK economist at Barclays Capital, said: "This is a good illustration of how macro-prudential policy is viewed as a useful complement to monetary policy. The minutes of the September MPC meeting showed the MPC had become concerned that stresses in bank funding would lead to a tightening in credit conditions. With the FPC, the Bank now has a vehicle for more direct intervention in credit markets, taking some of the pressure off monetary policy for controlling the credit cycle."

The FPC has yet to decide on its powers but on Wednesday proposed a range of measures, including setting loan-to-value ratio caps for mortgage borrowers, margin requirements, maximum leverage ratios for banks, variable capital buffers and risk weightings on loans, and more transparent disclosure requirements.

Separately, the Bank is expected to hold off on pumping more money into the economy when the MPC meets next week, according to a poll by Reuters. The survey of 60 economists found that the majority believe the Bank will wait until November before doing another £50bn of quantitative easing.

What the banks said... and what they really meant

They said: the Committee recommended that banks should take any opportunity they had to strengthen their levels of capital and liquidity so as to increase their capacity to absorb flexibly any future shocks, without constraining lending to the wider economy. This could include raising long-term funding whenever possible and ensuring that discretionary distributions reflected any reduction in profits.

They meant: we want banks to bulk up in case of a recession. But the way to do it is not by starving businesses and households of credit but by slashing those outrageous bonuses and being stingy with dividends.

They said: the Committee also advised the FSA to encourage banks to manage their balance sheets in such a way that would not exacerbate market or economic fragility. For example, at the present time, some actions taken to raise capital or liquidity ratios could potentially worsen the feedback loop between the financial sector and the wider economy and so should be avoided.

They meant: OK, we know we said we want banks to be stronger but right now we don't mind if they get a little weaker. After all, banks will make losses in a recession - that's what happens. What we don't want is lending to dry up again - that's not good for the recovery. We can come over all strict again when the troubles are over.