The UK is now officially heading towards a recession, Bank of England chief Mervyn King finally admitted last week as Brits struggle to cope with rising inflation. And the latest Financial Stability Report points to the UK banking system as an area of weakness that has caused the UK economy to collapse.

Mortgage lending has now become so bad that first time buyers are turning to rental accommodation and house prices are expected to have fallen by 25 per cent by the end of 2009, which will, according to the report, push more people into negative equity.

According to the report, banks took advantage of the good times when liquidity was rife without pre-empting the bad times that are now upon the UK. As a result, liquidity between the banks dried up, forcing the UK Government to launch its rescue plan on October 8.

Commenting on the report’s findings, Bank of England deputy governor Sir John Gieve said: “The instability of the global financial system in recent weeks has been the most severe in living memory. And with a global economic downturn underway, the financial system remains under strain.”

Talking of the Government’s emergency action, he added: “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.”

However, he added that more action is needed to protect the UK against similar fates in the future: “Looking further ahead, we need a fundamental re-think of how to manage systematic risk internationally,” he said.

“We need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the danger they bring to the wider economy.”

The report mirrors the thoughts of Gordon Brown yesterday as he stressed that the financial crisis will not be stopped with just one solution but a ‘comprehensive set of measures’ is required. And, according to Brown, these measures should include a re-evaluation of the UK banking system that has a clear structural problem.

© Fair Investment Company Ltd