I am grateful to my hon. Friend for making that point. He is absolutely right. Of course accounting systems and procedures are very much part of the suite of issues that must now be examined. I shall touch on that subject again when I come to the Basel accords, as there is an overlap between the point that he made and the issues that arise in that context.
I was discussing the asset price inflation that drove all the recent occurrences, and the chain of causality that began to unravel. It is now well known that the problems were initially exposed by the downturn in the US housing market, which in turn exposed the sub-prime lending that had been going on. Those issues were rapidly transmitted through the international banking system and led to banking collapses in some instances, as well as the threat of collapses on a wider scale. That in turn led to a crisis of confidence in the banking system, which in turn sent LIBOR spiralling, thereby producing the current global slowdown in economic activity.
All those events almost brought the international banking system to the brink of a catastrophic collapse, which was averted only by the concerted and co-ordinated action of Governments around the world injecting £3 trillion of resources into the banks. It is worth recording the scale of the losses, as is it known, although those figures may change as time goes on. Government intervention at the moment is designed to cover potential known losses in the UK banking system alone of some £122 billion; in the euro area, the loss is estimated at $784 billion and in the United States it is $1.57 trillion.
To return to the UK, the Government recapitalisation that I just mentioned, which averted a complete catastrophe in the banking system, has lifted the capital ratios a bit, from an average of about 8.5 per cent. to about 10 per cent. However, we learn from the Bank of England's financial stability report that even at these levels, UK banks would still need to shed about £1 trillion-worth of assets—almost equivalent to the size of the UK economy—to get their leveraging levels back to what they were in 2003. That is a striking illustration of the extent of the problem and the degree to which that overhang is still there and remains to be dealt with, even after the banking rescues have taken place. That will only be done either by a very long-term correction, which would mean correspondingly tight credit and slow growth for a long time, or, possibly, even more state support on top of what we have already seen.
We also have to address the moral hazard question that has come about as a result of the Government intervention. Put simply, banks now know that they will be bailed out. What has long been suspected has been confirmed; they are too big to fail. Does that raise a question—I am interested to know what the Minister thinks about this—about the incentives for banks to behave responsibly in future, knowing, as they now do, that they are too big to be allowed to fail? The Government intervention, which was clearly the right thing—I am not questioning that for a moment—has brought into existence the concept of shadow equity which, in effect, is behind every banking institution and is funded by every taxpayer.
The next question, as I mentioned at the outset, is what exactly happened on the regulatory side and what can we learn from it. It breaks down into three sub-questions. First, who are the key players in setting international banking regulation? Secondly, were the failures administrative or systemic? Thirdly, how can the failings be corrected? The first and most obvious key players are the International Monetary Fund and the World Bank, which were brought into existence in 1944 under the Bretton Woods agreement. Those institutions were established to step in where markets failed and to mitigate the anticipated excesses of global capitalism. They were also designed to prevent beggar-thy-neighbour policies, which everyone meeting at Bretton Woods believed had contributed to the economic and political catastrophes of the 1930s. I am sure that they were right in that conclusion, but it is interesting to look at the IMF's remit, because it reflects what the debaters at Bretton Woods were trying to prevent from happening again—their perspective was the need to avoiding the problems of the inter-war years. The IMF's remit focuses heavily on trade and trade regulation, as well as on exchange rates, but it says little about preserving financial stability.
Looking at the history of Bretton Woods, there was an interesting argument at the time between those who wanted to bring out of the conference global institutions, global rules, global financial governance and, possibly on the part of some, a global currency—an interesting echo of the debate around the table in Washington later this month—and those who argued for sovereign independence for states in their banking and trading systems, but with the means of co-ordination and general oversight and with the existence of reserve funds to give support to countries in trouble largely as a result of trade deficiencies. That is a different context from the one that we now face.
I think that people can see structural weaknesses in the IMF. I raise that point because if the discussion is going to be about the IMF as a key player in the restructuring of the regulation of international banking, other questions need to be addressed before reaching that conclusion. The first problem with the IMF as currently constituted is that it is seen around the world as the advocate of the Washington consensus. The US dominance of the IMF as an institution is undeniable. The US is the only member of the IMF with a 17 per cent. vote on the board, and that 17 per cent. is crucial, because most major decisions taken by the IMF require an 85 per cent. vote and the United States alone has the veto. In addition, US influence over the IMF has been ramped up over the years. Every time the IMF wants to renegotiate the quotas it has to gain US congressional approval to do so. Congress, not unreasonably, poses ever more conditions as a quid pro quo for supporting the revamping of the quota system, so it has its hands on the IMF's policy stance, and that is recognised around the world.
The IMF, in the present context, is seriously underfunded. Discussions are taking place, in which our Prime Minister is involved, to try to resolve its funding situation. However, even if the funding is sorted out, questions still have to be asked about the IMF as an institution and about its stance, because the Washington consensus is now damaged goods after the sub-prime catastrophe. One wonders whether the IMF will suffer reputational damage and whether that can be put right. It is not just about recapitalising the IMF; it is also about revising its role. People are calling for it to have an enhanced role in the supervision of international banking and to provide early warnings; to be a genuinely global supervisor and to have a strengthened brief on financial stability. All those things are needed—I do not think there is any question about that—but if any of that is to be achievable in a robust, sustainable way, there must be fundamental reform of the governance of the IMF. I am interested to hear what the Government think about that.
The second major institution that we have to consider is the Basel Committee on Banking Supervision, including the accords that have grown out of it, which was not set up by the G10 until the 1980s, long after the Bretton Woods discussion. The Basel accords eventually plugged the gap in the IMF's remit, but they did so a long time afterwards. They have not come out of this saga very well either, yet a great deal of store is being set on their coming to the rescue of the international banking system. Basel I, the first set of accords, was long ago acknowledged as weak, which led to all the negotiations that ultimately resulted in Basel II, which is still advocated by many as the gold standard of financial supervision. However, the experiences of the past year show that Basel II, too, has fundamentally failed. Long negotiations led up to Basel II, throughout which the banks lobbied hard for a system based on two core principles: internal risk rating—the banks doing their own assessment of their exposure to risk—and low capital thresholds. In the negotiations that led to Basel II, the banks got both those things, so they really won again.
It is worth looking at some of the detail of Basel II, which allows banks with sophisticated risk-taking models—that is now most of them—to select their capital adequacy ratio from an à la carte menu of options provided by the Basel Committee. Basel II also means that banks can use their own measures to determine their exposure to risk. There is no independent, externally verified risk measurement. The banks measure their own exposure to risk.
Basel II also allows the banks to allocate their risk weighting to each of their assets, including off-balance sheet assets. To read what the banks said when Basel II was negotiated gives the impression that they thought that they were moving into a world with a huge regulatory hurdle, but Basel II was the guidance that told banks that it was fine to reduce capital charges on lower-risk lending—that is Basel II's phrase, not mine—which was defined as retail loans and residential mortgages. It is extraordinary that it said that it was okay to have lower risk protection on those loans because they were safe.