But as the crisis deepened in late September, it became clear that we needed more than a case by case approach here to tackle the continuing loss of confidence in the banking system in the UK, in euro area and in the US. On 8 October therefore we announced a comprehensive package of measures including support for recapitalisation, guaranteed funding and enhanced liquidity. That very quickly became the template for action in other advanced and some emerging countries. The central plank of the package was the offer to underwrite capital issuance of at least £ billion and it is important to be clear what that was intended to do. It was not to establish new regulatory minimum ratios. It was intended to underpin confidence in the banks and to ensure that each institution would have a sufficient capital buffer both to absorb losses that are likely to arise during a recession and to continue lending on normal commercial criteria. Under the new Basel II rules the ratio of capital to risk weighted assets is almost bound to fall as arrears and losses mount. The aim of the package was to create the headroom for that to happen and to remove the capital pressure on banks to deleverage quickly by refusing even good credit requests. The capital raising is not complete of course but the process is underway. Banks and building societies have already secured around £ billion of guaranteed funding in the market and has facilitated new bank debt issuance without the need of a guarantee.
We need to ensure that banks build up resources in good times to a greater extent, which can then cushion the shock in bad times. I think of this as “protecting banks from the economic cycle”. But we have seen also how the financial sector can drive the wider business cycle, by becoming over-confident in the upswing and over-constrained (by lack of financial resources – capital and liquidity) in the downswing. It seems to me that mechanisms which oblige banks to build up resources in good times can serve a second useful purpose of dampening the economic cycle. I think of this as “protecting the cycle from banks”. We need two-way protection and I would like to describe three ways you might go about providing it. The first is the Spanish system of dynamic provisions, which requires banks to build a general reserve that can be drawn on in downturns. Each period, banks are required to make general provisions equal to the difference between the “inherent” losses (based on the growth of loans and a long-term average of incurred losses) and the specific provisions on impaired assets for the period. The difference, if positive, is treated as an expense in the profit and loss account. If negative, it is treated as income – provided that the general reserve has been previously built up to the required level. The specific provisions made by Spanish banks fluctuate substantially through the business cycle, as one would expect, falling during upswings and increasing in downturns.