The flow of funds into the US was re-exported to the advanced economies, especially through the growing securitisation markets, and helped finance the rapid increases in house prices in the UK (Chart 2) and many other countries. And that internationalisation of markets was reflected also in the build up in our banks of portfolios of AAA-rated securities which offered a slightly better yield than traditional bonds and many of which were based on sub-prime assets. BIS Review 145/2008  1  So when losses emerged in sub-prime market, they not only hit US banks but ricocheted through the international financial system. Much of the commentary has focused on the structured credit losses in banks’ trading books and treasuries and they have certainly been large. But equally as important was the impact on the liability side of balance sheets. Banks had not only expanded their balance sheets too far, they had in the process become reliant on wholesale funding markets which had not been tested in a downturn. In the UK, the gap between customer lending and deposits moved from zero at the turn of the century to over £ billion in 2008 H1 (Chart 3). That proved a structural weakness when investors realised that the AAA label concealed substantial and uncertain risks and withdrew from the securitisation markets. Just as the origins of the crisis lay in global imbalances its effects are also global.
Our new approach is designed to counter the risk that policy is too accommodating in upswings and too harsh in downturns. Two important principles stand out for me: first, that we must carry out financial regulation with an eye on conditions in the real economy, which means promoting stable and sustainable credit creation and growth; and second, we should always be prepared to look to the risks ahead, and exercise sensible judgment. The financial crisis has taught us in the most painful way of the dangers of waiting too long to take action and then being unable to prevent the worst consequences of delay. The FPC has recommended that British banks make sure their capital level is high enough to withstand future threats. Some banks will need to increase their equity capital for a given level of risk in their balance sheets. Concerns have been expressed that this change will harm lending to the UK economy. I do not agree with these concerns. Equity capital is not money that has to be stashed away for a rainy day and thus put to no good use. It is the shareholders’ stake in the company. In nonfinancial companies, shareholder capital or equity is used to finance the acquisition of assets. The same is true for banks. Equity finances the provision of loans to households and companies, and those loans are the banks’ assets. In that sense, capital supports lending by banks and does not substitute for it.