ClickAJob News

The Bank of England estimates the global banking crisis will create losses of £1.8 trillion, and is warning of future crises for hedge funds and insurance.

The central bank's Financial Stability Report states: "Pressures on the UK banking system have been arguably as severe as at any time since the beginning of the First World War."

It estimates total losses from the crisis to stand at $2.8 trillion (£1.8 trillion) – with $1.58 trillion lost in the US and £122.6 billion in the UK – and warns of further traumas along the line.

Dangers from hedge funds being forced to liquidate asset holding is raised – as the investment vehicles are seeing investors take their cash away to safer shores.

Insurance companies are also seen as a risk – holding a significant proportion of their assets in equities and corporate bonds that have dropped in value.

"Unlike banks and hedge funds, however, insurance companies generally do not employ much leverage and have long-term liabilities. So insurance companies seem relatively well placed to avoid liquidity difficulties," the Financial Stability Report states.

"Risks could arise, however, if the value of insurance companies’ investments were to fall below regulatory capital requirements."

Dangers also exist to emerging markets – dependent on foreign funding – with Iceland's dependency highlighted.

However, the Bank also finds losses on mortgage-backed securities – which created the spark that led to the financial inferno - have swung too far and the markets are knocking down their values more than the risk of default behind them truly stands.

A further problem highlighted was how UK banks have tapped funds from international wholesale markets.

In 2001 UK consumer lending matched consumer deposits. By the first half of 2008 there was a gap of £700 billion as lending raced over deposits.

The report states: "This growth in bank balance sheets understated the broader expansion in risk-taking. Many financial institutions exploited strong demand for yield from elsewhere in the financial system — including among conduits and structured investment vehicles — to generate higher profitability."

In response, it sees banks are now relying more on savers.

However, this is not without problems. With banks competing for cash, interest rates will rise for savers, but lenders may be forced to cut lending to maintain capital bases.

"If banks aimed to reduce the gap [between deposits and lending] to 2003 levels (when it was around £265 billion) over three years… customer lending would slow significantly from earlier growth rates."

But the Bank does claim measures from the government should lessen the effect.

Sir John Gieve – deputy governor of the Bank of England – said: "And with a global economic downturn underway, the financial system remains under strain.

"But it is better placed as a result of the exceptional package of capital, guaranteed funding and liquidity support. That is helping to underpin the banking system both directly and by demonstrating the authorities’ determination to do whatever is needed to restore confidence."

He added a "fundamental re-think" was now needed on how to manage systemic risk internationally.