Global intervention should steady the banking system but it will also put big constraints on banks, the Bank of England said this morning, six months after it said it expected confidence to return to financial markets.
In its twice-yearly Financial Stability report, the BoE also said losses may be much less than markets calculate, reiterating a point it made in its April report - before the credit crunch spiralled into the worst financial crisis in living memory.
"Exceptional interventions by governments and central banks should help stabilise the banking system in the period ahead," the BoE said.
"While there are still risks in the wider financial system, the immediate response to the measures has been positive."
In April, the BoE gave a fairly upbeat assessment of how severely the credit crunch would affect markets and the wider economy, but the central bank's latest report is more cautious.
"The instability of the global financial system in recent weeks has been the most severe in living memory," said BoE Deputy Governor John Gieve. "And with a global economic downturn underway, the financial system remains under strain."
"We need a fundamental re-think of how to manage systemic risk internationally. We need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the dangers they bring to the wider economy."
Central banks and governments globally have made as much as £5 trillion available in support funding since April, but that level of help will have consequences, the BoE said.
"Reducing reliance on the official sector as a source of funds is likely to be a significant constraint on banks' activities over the medium term," the BoE said.
Banks will also need to lower their exposure to short-term wholesale funding and their leverage to improve the quality of their balance sheets, the central bank said.
"Both are consistent with a period of tighter credit conditions for the real economy, compared to the period prior to the turmoil," it said.
The roots of the credit crunch lie in the unwillingness of banks to lend to each other because of fear of what toxic, hard-to-value assets may be lurking.
That has frozen up markets and cut vital credit lines to businesses, households and would-be homebuyers, helping to drive Britain towards its first recession since the early 1990s.
The BoE said "there are tentative signs that counterparties have become more willing to lend to banks on an unsecured basis" after Britain's recapitalisation package and similar moves by other countries.
The government offered to inject 50 billion pounds into banks and guarantee new short- and medium-term debt issuance at the start of October.
The BoE also extended its Special Liquidity Scheme - under which banks can swap hard-to-trade mortgage assets for government debt.
Reuters