• Governments too slow to act, warn central bankers
• CBI sounds warning over ‘worrying’ bad debt levels

Taxpayers around the world still face potentially large losses because governments have failed to act quickly enough to remove toxic assets from the balance sheets of key banks, the world’s leading central bankers warn today.

Despite months of co-ordinated action around the globe to stabilise the banking system, hidden perils still lurk in the world’s financial institutions according to the Basle-based Bank of International Settlements.

“Overall, governments may not have acted quickly enough to remove problem assets from the balance sheets of key banks,” the BIS says in its annual report. “At the same time, government guarantees and asset insurance have exposed taxpayers to potentially large losses.”

It comes as the CBI employers’ organisation reports that the British banking system remains under pressure, despite tentative signs of green shoots in the financial sector.

In their latest quarterly financial services survey, the CBI and PricewaterhouseCoopers (PwC) say many parts of the sector expect business volumes to rise in the next quarter after 21 months of falls. But despite these early signs of optimism, Ian McCafferty, the CBI’s chief economic adviser, cautioned that banking remains “under pressure”.

“Conditions remain challenging, particularly for the banks. Although demand looks like it is beginning to recover, it is doing so from a very low base. We can still expect lower profitability, significant job losses and cuts to investment in the coming months. The rising levels of bad debt are a further worry for the industry,” he said.

His note of caution chimed with the warning from the BIS. As one of the few bodies consistently sounding the alarm about the build-up of risky financial assets and under-capitalised banks in the run-up to the credit crisis, the BIS’s assessment will carry weight with governments. It says: “The lack of progress threatens to prolong the crisis and delay the recovery because a dysfunctional financial system reduces the ability of monetary and fiscal actions to stimulate the economy.”

It also expresses concern about the dilemma facing policymakers on when to start reining in the recovery. “Tightening too early could thwart the recovery, whereas tightening too late may result in inflationary pressures from the stimulus in place, or contribute to yet another cycle of increasing leverage and bubbling asset prices. Identifying when to tighten is difficult even at the best of times, but even more so at the current stage,” it says.

The CBI survey confirms there are still problems beneath the surface, despite growing optimism. Respondents said the value of non-performing loans, or “bad debt”, increased at its fastest rate since the survey began in 1989 in the second quarter of the year and a similar rise is expected in the next quarter.

The survey also found that banks widened lending spreads to a record degree in the three months to June. That provides some support to banks’ profitability, which was broadly flat after six consecutive quarters of decline, but could choke off demand for loans from borrowers and weigh on recovery.

While optimism regarding the overall business situation remained firmly negative, according to the CBI, the rate of decline had slowed on that in recent quarters. However, business volumes fell at the fastest rate since March 1991, but are expected to start to rise over the next three months.

John Hitchins, UK banking leader at PwC, said: “The UK banking industry has seen a further decline in confidence but the rate of decline is slowing.” McCafferty warned the overall optimism in the financial services sector “masks” the fact that some sub-sectors, such as building societies, are still having a very tough time.

About 15,000 jobs were slashed in the financial services sector in the three months to June, compared with 17,000 in the first quarter of the year. The CBI expects a further 13,000 jobs to be chopped over the next three months. A total of 34,000 jobs were lost in the financial services sector in 2008.

Nearly all respondents agreed that it will take longer than six months for normal market conditions to resume.