* King sees "disturbing" hunt for high-yield investments * More bank capital needed, euro zone problems not over * Goldman Sachs attempt to avoid UK income tax "depressing" By David Milliken and Huw Jones LONDON, Jan 15 (Reuters) - Bank of England Governor MervynKing warned on Tuesday that investors appeared to be makingworryingly risky bets at a time when Britain's economy was weakand its banks had not yet recovered from the financial crisis. Speaking before a committee of British legislators, Kingalso said Britain's banks would have to raise large amounts ofcapital as fines for rigging the Libor benchmark andcompensation to investors for mis-sold loan insurance, hitreserves. "The economy is operating well below full capacity, thebanking system is in a stretched position and we are clearlystruggling to find instruments to ensure an economic recovery,"King told the committee. "A combination of a weak recovery, and ... people searchingfor yield in ways that suggest that risk isn't fully priced(in), is a disturbing position. It's one that we will have tomonitor very carefully," he continued. British share prices have rallied to near their highestlevel since early 2008, bolstered by an easing in the euro zonedebt crisis and a U.S. budget deal. But King said the dangers were not over, despite EuropeanCentral Bank efforts and a deal on bank supervision. Figuresearlier on Tuesday showed that Germany's economy shrank at theend of 2012, and Britain's is forecast to do the same. "The actions of the ECB have been successful in calmingmarkets and in buying time. What it can't do, because no centralbank can do this, is to resolve the underlying real challenges.And in that sense, banking union is certainly not a magicanswer," King said. He was presenting his latest assessment of the health ofBritain's financial system, and he and his colleagues repeatedwarnings that British banks needed to raise more capital and mayhave underestimated future fines for bad behaviour. He also condemned as "depressing" plans by U.S. investmentbank Goldman Sachs to enable its staff to avoid Britain'stemporary 50 percent rate of income tax. From April the central bank's Financial Policy Committee(FPC), which King chairs, will have powers to force banks toincrease their cushions against future losses - something manybanks and analysts say would be costly and of little benefit. The committee expects regulators to report back by March onhow much capital banks need to raise in the short term, and onMonday it set out details of how it would curb booms in banklending in future. At the same time, the central bank is trying to encouragebanks to increase lending to home buyers and businesses throughits Funding for Lending Scheme (FLS) and resolve a moreimmediate source of weakness in the British economy. Andrew Bailey, a Bank of England official who is also a topregulator at the Financial Services Authority, said the FLSappeared to have increased mortgage availability, but that thejury was still out on how much it would increase net lending. Another FPC member, Michael Cohrs, forecast that the bodywould face strong criticism from banks, politicians and thepublic as soon as it acted to curb lending. "If the party ever gets started again and we try and takethe punch bowl away there will be a huge row, and only if we areseen as being highly accountable ... will it be acceptable toyou and your constituents," Cohrs told legislators. MORE CAPITAL King made it clear that Britain's banks would have to raiselarge amounts of capital as fines for rigging the Liborbenchmark, compensation for mis-selling loan insurance and arethink of how banks tot up risks, hurt reserves. Royal Bank of Scotland, majority owned by the UKgovernment, is braced for fines of between 400 million and 500million pounds for Libor rigging as soon as next week, sourcestold Reuters on Tuesday. "The real threat to taxpayers comes from banks that areinadequately capitalised," King said. "There is a prima faciecase for believing the problem is sufficiently big ... foraction to be required." Legislators pressed FPC members to give an estimate of howmuch capital would be needed, but they all said it would bepremature to do so. "We do think there is a shortfall of capital in the system.It's a big number," Cohrs told the committee. The FSA's Bailey said restructuring and more capital wouldbe needed before the government could sell its stakes in RBS andLloyds. "If you want to sell the government shareholding, you haveto sell it in an institution that has a balance sheet andbusiness model that has a stable future," Bailey said.
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