HIGHLIGHTS-BoE's King, FPC members in UK parliament hearing

LONDON Jan 17 (Reuters) - Bank of England Governor Mervyn King and fellow members of the Financial Policy Committee gave evidence on the central bank's Financial Stability report to parliament's Treasury Committee on Tuesday.

Following are highlights from the session, which also featured BoE Executive Director for Financial Stability Andrew Haldane, and interim FPC members Bob Jenkins and Michael Cohrs.

KING ON "ASTONISHINGLY" LOW UK BOND YIELDS

"Quite astonishingly the UK government managed to issue a 35-year (index-linked) bond at a negative real interest rate recently. This is a world none of us ever thought we would be in.

"It's telling us something really profound about what's going on. But if those are the likely long term real interest rates, you would expect to see very high ratio of asset prices and debt to income."

"There's absolutely no doubt that one of the vulnerabilities of the world economy is if these low interest rate were to move up sharply."

KING ON ECONOMIC OUTLOOK/SOVEREIGN DEBT CRISIS:

"What we are seeing is a problem in the world economy and it's vital that we try and work with our partner central banks and governments abroad, and we try and do this with the G7 and the IMF and the G20, to try to move to a position where we can get back to steady growth and 2012 will pose a challenge in that respect because some of the big emerging market economies are slowing down."

"Within Europe there is a particular challenge clearly, the European Central Bank with the operations it announced just before Christmas I think has gone a long way to try to ease some of the immediate financial pressures on banks in the euro area. But of course the European Central Bank can't on its own change the underlying problems which are a challenge to the euro area which are loss of competitiveness and current account deficits that....by the laws of arithmetic need financing. They must be financed somehow, the question is who is going to finance them and how.

"Creating yet another liquidity facility buys more time but we have bought a lot of time over the last two years and it's hard to argue that the time that was bought has been used productively. The European Central Bank can do so much but no more. In the end, it has to be a question for the governments of the euro area."

ANDY HALDANE ON UK BANK BUFFERS

"What we have seen over the last six months is that the buffers UK banks built pre-emptively have been run down to cushion the effect of the pressures that I've mentioned. I think that's tremendously important. I think we've gone 30 years within the regulatory community without properly emphasising that these rainy day resources are there to be used in a rainy day and at the moment it's pouring. I think at the moment that message is getting through."

ANDY HALDANE ON BANK CAPITAL RATIOS FALLING

"Buffers are there to buffer. I think we've seen that happen in respect to liquidity. We want to see it happening in respect to capital. That is why now the FPC recommendation in December we specified the level of capital -- not the ratios.

"Personally, I would be perfectly happy to see banks' capital ratios falling for the moment in the current weather. That's not the same as them building up the level of capital to guard against even worse storms ahead....I think the rest of the world is slowly waking up to the same point."

KING: MARKETS SHOULD FOCUS ON BOND YIELDS, NOT RATINGS

"I think the way round that is to put less focus directly on what the ratings agencies say and more on what the market as a whole is saying in terms of sovereign debt, for example the spread of the yield on the sovereign debt of a particular country.

"It's one thing to say these rating agencies are just reacting trying to make up for mistakes of the past, it's another to ignore the message from the markets that the yield on government debt has moved to very high levels. That isn't the rating agencies driving that, that is the judgement of very many investors all around the world, and that is something that we should focus on much more than the actual rating."

KING ON RATINGS AGENCIES:

"To my mind far and away the best way of dealing with this is for public authorities around the world to be seen to rely far less on ratings than they do and central banks are right at the heart of this."

"There ought to be a market for ratings in the end and we want as much competition as possible so that we have a reputation that can be used."

"What we need to do is to move to a point, and I think markets have gone some way towards that, where they pay less attention to the verdicts of the ratings agencies. From that point of view I think we can be reasonably encouraged that the response of financial markets to the downgrade of France for example has been pretty muted."

"I think the way around that is to put less focus directly on what the ratings agencies say and more on what the market as a whole is saying, in terms in the sovereign debt case for example, of the spread or the yield on the sovereign debt of a particular country."

KING ON BONUSES FOR SENIOR BANK EXECUTIVES

"I would say one final word. There are are four big banks which dominate the market for lending in the UK, and we've been through a crisis where the squeeze on real living standards has been unprecedented. The current squeeze on living standards has been on people who have been in no way responsible for this crisis. I think the reputation of those institutions will be affected if their senior executives reward themselves, particuarly in a period when the banks, in terms of their share prices, have hardly been stellar."

KING ON BANK BALANCE SHEETS, BONUSES

"As far as FPC is concerned, we can merely reiterate that our view is that banks would be very well advised to ensure that wherever possible they improve the resilience of the balance sheets of their bank so that when there are surprises down the road, they'll be in a stronger position, they won't have to cut back lending to the real economy.

"At present the best way to do that is to ensure that rather than distributing a great deal of dividends or compensation, they plough it back into the balance sheet of the banks."

WRITTEN RESPONSE FROM THE COURT OF THE BANK:

"We support the Treasury Committee's recommendation that future Governors of the Bank should be appointed for a single eight-year term."