LONDON (Reuters) - Britain's banks need to start preparing for a financial environment in which they are no longer "too big to fail", Bank of England Deputy Governor Jon Cunliffe said on Tuesday.
Taxpayers in Britain poured 65 billion pounds into banks during the 2007-09 financial crisis and the BoE wants to ensure that no bank is so big that letting it fail would risk the market mayhem seen when Lehman Brothers went bust in September 2008.
Speaking at an event held by Barclays (BARC.L) bank, Cunliffe cautioned lenders that once new rules are in place to ensure that no bank is too big to fail, market liquidity won't return to levels seen in the run-up to the financial crisis.
"Liquidity premia were likely too low and liquidity risk very probably under-priced before the crisis," Cunliffe said.
"Market participants will need to recognize this change in market structure and adjust their balance sheets accordingly," Cunliffe added.
One of the rules being finalized is a requirement to hold a buffer of bonds that can be used to shore up a failing bank once it has burned through all its regulatory capital.
But Cunliffe said the aim won't be to resurrect every failed business such as by arranging "hasty shotgun weddings" or forced takeovers.
The amount of "bail-in" bonds that banks will be required to hold will only be enough to keep critical operations such as payment systems going to avoid harming financial stability, while the group can be safely wound down over time.
"We are not seeking an amount of 'Gone Concern Loss-Absorbing Capacity' capable of resurrecting any failing banks including the global giants," Cunliffe said.
Cunliffe's boss, Bank of England Governor Mark Carney, who is also chairman of the G20 economies' Financial Stability Board, said in March that the board wants to crack "too big to fail" bank barriers by Christmas.
Another global rule being finalized is the leverage ratio, which acts as a cap on a bank's balance sheet.
A preliminary ratio of 3 percent was set and global regulators will decide in 2017 what the final minimum level should be, though countries like the United States are already moving to a much higher requirement.
Some bankers expect Britain's lenders will be required to have a leverage ratio of 4 percent or above regardless of what's decided at the global level.
The government has asked the BoE's Financial Policy Committee to review if the global leverage rule should be introduced earlier in Britain.
Cunliffe said the Bank will hold a public consultation on this and on a possible new power to vary a bank's leverage ratio.
Regulators are putting pressure on the swaps industry to revise trillions of dollars of contracts by inserting a clause that allows for such contracts being temporarily prevented from being closed out while a bank is being wound down.
The industry says that big investors or "buy side" players have legal difficulties with this. But Cunliffe signaled that regulators won't be deterred.
"The way forward will likely entail the major dealers, the 'sell side', who together account for around 80 percent of contracts in the market, moving first," Cunliffe said.
Ensuring that no lender is 'too big to fail' is not only seen as crucial to shielding taxpayers but also to restoring trust among regulators after the collapse of Lehman Brothers soured relations, leading to unilateral national measures on capital rather than global coordination.
Reporting by Huw Jones; Editing by Jemima Kelly and Hugh Lawson