Alistair Darling last night paved the way for the Bank of England to become legally responsible for the financial stability of the City in a bid to stave off another Northern-Rock style banking collapse.

The Chancellor used his inaugural Mansion House speech to the City last night to unveil a shake-up of the Bank including a new Financial Stability Committee that will oversee the Governor Mervyn King’s actions and hold him accountable if potential banking crises are not spotted and averted.

No mention was made of the departure of Sir John Gieve, the Deputy Governor for Financial Stability at the Bank of England, which was leaked this evening.

The committee, Mr Darling said, will be staffed with members of the Bank’s own internal Court and, as yet unnamed, eminent City figures handpicked by him. “The aim is to hold Mervyn accountable for his actions”, one insider said yesterday.

Mr Darling has made it clear he was disappointed with the way the Bank failed to perform its financial stability role last year as the credit crisis took hold and Britain’s banks began clamouring for help. To avoid a repetition of the crisis, the Chancellor said the Government would now provide the Bank with a “formal legal responsibility” for financial stability, alongside its existing role in monetary policy.

The measures are part of the Treasury’s new banking reform bill which was first laid out at the start of the year. Mr Darling said that he would provide more details of the committee today in a letter to John McFall, the chairman of the Treasury Select Committee. A consultation document is also due by the end of the month.

At that time, the Chancellor said he would also outline new powers for the Financial Services Authority, the City watchdog, to help prevent the failure of a bank as well as to address other pressing issues such as market abuse and insider trading.

“We must do everything possible to prevent problems which could pose a wider threat to stability,” the Chancellor said, adding that the new powers would: “Reduce the likelihood of failure, lessen the impact if it happens and ensure that savers are properly protected”.

But the Chancellor’s speech left many questions unanswered. Chief among them is the location of a new “special resolution regime” for banks, which will have the power to declare them bust and step in to protect depositors’ money. The Treasury, which is a member of the Tripartite with the FSA and the Bank, had earlier suggested the power should lie with the FSA. However, the Conservatives and the Treasury Select Committee have said the banking supervisor might be reluctant to use those powers given a failure would highlight its own deficiencies in spotting the problem in the first place. Mr King has also endorsed this view when he said, in April, that the power should “not be with the supervisor but with a different body”.

Mr Darling’s speech comes as the Chancellor faces unprecedented pressure, with Britain’s economy slowing and inflation rising as global fuel and food prices soar. In May, the core inflation rate rose more than expected to 3.3 per cent, above the Bank’s 2 per cent target, raising speculation that a rise in interest rates could soon follow.

Those fears were heightened last night after Mr King re-affirmed the Bank's commitment to targeting inflation. “There should be no doubt that the MPC is prepared to take whatever action is needed to return inflation to the 2 per cent target and to keep expectations of inflation in the medium term anchored to the target”.

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