Contingency plans should be made to deal with an economic downturn as severe as the recession that struck in the early 1990s, according to the head of the City's watchdog.

Hector Sants, chief executive of the Financial Services Authority, has warned banks they will need to raise billions of pounds in capital to cope with a worsening credit crunch.

His comments follow yesterday's announcement from the Royal Bank of Scotland (RBS) that it made pre-tax losses of £691m during the first half of this year - the second biggest UK banking loss in history.

For the same period last year RBS posted profits of £5 billion.

In an interview with the BBC Mr Sants said he had expressed his fears "fairly forcibly" to bank bosses.

Asked whether financial problems could become as bad as those of the 1990s, Mr Sants said banks should "plan on that type of assumption" and have enough capital behind them to absorb the impact of the credit crunch.

June saw the biggest increase in the number of people claiming unemployment-related benefits since 1992, while, according to the Council of Mortgage Lenders (CML), almost 19,000 homes were repossessed in the first half of this year which is 48 per cent rise compared to the first six months of 2007.

Homeowners are struggling to meet mortgage repayments and are unable to remortgage their homes to free up extra funds.

Mr Sants also warned there would be "consequences" for banks that pay employees big bonuses for risky deals and said such rewards had played a part in causing the economic problems now being faced.

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