Mervyn King told MPs yesterday, banks should pay upfront to build a multi-billion pound fund that would help compensate depositors quickly when an institution failed.

The Bank of England governor’s comments come as many banks are struggling to rebuild their balance sheets, making ministers wary of forcing the industry to pay into a pre-funded pool of assets that guarantee’s savers’ deposits, and the costs of dealing with future bank failures.

Kitty Ussher, economic secretary to the Treasury, said “legislation would include power to pre-fund compensation payments, but would only be used if there were a market consensus”.

However, Mr King wants the government to toughen this position before it finalises its plans for banking reform. “Banks should contribute on a scale that would build a fund of many billions over ten years, paying more if they had riskier business models,” he said

“Some element of pre-funding is desirable . . . I hope that issue will still be on the table,” he added.

Although no one suggesting seeking large sums now, or expecting to rely on free funding, he said that “if you wait until there is a problem, that’s a pretty bad time to ask banks to put up a large amount of money’’.

Questioning Mr King’s proposal for “risky” banks to pay more into the fund, Angela Night, chief executive of the British Bankers Association asked, “How is riskiness assessed? Are big institutions classed as risky because they have a large number of customers even though they are well capitalised? Or are smaller banks regarded as riskier even though they have fewer customers.” 

Mr King and Ms Ussher were speaking to MPs scrutinising Treasury proposals for reforming financial stability arrangements proved inadequate by the collapse of Northern Rock last autumn.