And bonuses and pay rises must be resisted in the City, the Bank argued in its financial stability report.
“Bank’s boards should apply restraint in distribution of profits to equity holders and staff,” it said.
Alternative payments to staff, such as “contingent capital or subordinated debt” would increase banks’ ability to absorb shocks, the report suggests.
The recommendations form part of the plan by the Bank of England to get banks to build up capital.
Next year banks will have to pay back the bulk of £110bn made in loans to improve liquidity in the wake of the credit crunch.
“Funding is likely to remain a key challenge for the banks,” the report warned. Over half the repayments due in 2010–2012 fall next year, it said.
Loans under the Special Liquidity Scheme (SLS) were made under three-year fixed terms. With many expiring at the same time, and the Bank refusing to extend the scheme, some fear a “refinancing cliff” as banks scramble to replace the capital.
Yet the Bank insists that discussions have been held to “ensure there were credible funding plans in place to reduce banks’ use of the scheme in a smooth fashion.”
And banks are already “slightly ahead” of their voluntary repayment schedules, the Bank said.
In its final report of the year, the Bank reiterated the negative economic effect of weak lending.
Despite improved credit conditions in recent times, lending is still too low, it said.
Smaller companies are finding it particularly hard to obtain credit, according to the report.
And it warns that a fall in house prices still poses a risk to banks.
“Household sector credit risk remains vulnerable to further house price falls,” the report says.
It also highlighted risk of “overheating” from large capital flows to emerging markets.
However, UK banks’ direct exposure to European sovereign debt is “relatively low,” the Bank said.