Bank of England Governor Mervyn King today warned that "innocent bystanders" could be put at risk if banks failed to curb excessive risk-taking.

Mr King - addressing the British Bankers' Association's annual conference - said banks had been encouraged into reckless activities in the knowledge that central banks would step in as a last resort.

"If banks feel they must keep on dancing while the music is playing and that at the end of the party the central bank will make sure everyone gets home safely, then over time, the parties will become wilder and wilder," Mr King said.

"That might not matter were the consequences limited to the party-goers. But they are not. When the party ends, some innocent bystanders may lose their homes altogether."

Following the Northern Rock crisis, policymakers are grappling with the problem of how to allow a badly-run bank to fail without undermining the stability of the wider financial system.

Mr King - who has previously criticised the City bonus culture for encouraging financial risk-taking - said it was not easy for banks or authorities to resolve the problem because of the incentives to continue in the same manner.

Although too much regulation could mean there were "no parties worth going to", requiring banks to hold more capital could act as a "shock absorber" and strike a balance between burdensome regulation and excessive risk-taking, he added.

Mr King told 350 delegates and banking luminaries that the world "was passing through the most prolonged period of financial turmoil that most of us can remember" and the crisis was "not yet over".

But he put financial stability at the top of his agenda for his second term as Governor, saying: "I would like to see us establish a framework for financial stability that is on as sound a footing as the one we have successfully established for monetary stability."

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