Mervyn King, governor of the Bank of England, has said that banks should pay into an emergency failure fund to protect depositors’ savings if the firm runs into trouble.

The governor told MPs that such a fund would help banks to meet the costs of dealing with future banking failures akin to that experienced by Northern Rock almost a year ago.

The fund would protect depositors’ and prevent another run on a bank like that which befell Northern Rock when customers got wind of its troubles and queued up in droves to clear out their savings accounts.

Mr King said that banks should take responsibility and contribute at a time when it is possible to do so, instead of waiting until there is a problem, by which time it will be in no position to put up large amounts of funding to support itself.

The proposal comes in response to criticism from MPs about previous Treasury proposals for reforming financial stability measures; the existing ones proved inadequate when Northern Rock’s liquidity dried up last summer.

There are no expectations of banks paying in large sums in the immediate future, but eventually Mr King wishes to see a contingency fund of many billions. Additionally, those banks with the riskiest business models would be required to pay in more – the riskier the bank, the more they would have to pay into the fund

Angela Knight, chief executive of the ABI, was critical of the governor’s proposal to demand more money from ‘risky’ banks. She questioned how the riskiness of each bank would be determined, adding that it should not be defined by size or numbers of customers, because such banks could still be well capitalised.

The Bank of England tried to ease lending between banks in April with the hasty launch of its Special Liquidity Scheme, which allows banks to trade mortgage backed securities for government bonds, but this has also received criticism for rewarding banks that have failed to act within reasonable risk boundaries.

Meanwhile, Alistair Darling has moved to reassure investors that his proposals for dealing with failing banks will not trample on their interests, and would give more power to the authorities which would be able to seize a bank that was failing.

He told shareholders that while no banking system could or should prevent the failure of every single company, the government should do everything in its power to reduce the impact of such failings which threaten wider financial stability.

© Fair Investment Company Ltd