The Bank of England's Deputy Governor for Financial Stability has admitted that the central lender failed to grasp the full scale of Britain’s economic problems before the current financial crisis erupted.

In an edition of Panorama, to be screened tonight, Sir John Gieve tells the BBC that the Bank was aware that a bubble was developing in the housing market, as well as in the price of other assets, and that it was being fuelled by “crazy borrowing”.

However, it failed to comprehend how serious the problem really was and what the implications would be for the rest of the economy.

Sir John, who is a member of the Bank's rate-setting Monetary Policy Committee, also criticised the Bank’s policy of relying too heavily on interest rates to control conditions in the banking sector, saying that they were a “blunt instrument”.

“We need to develop some new instruments, which sit somewhere between interest rates, which affect the whole economy... and individual supervision and regulation of individual banks,” he said.

“We need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand.”

Sir John, who will step down next year to be replaced by Paul Tucker, claimed that if the Bank had lifted interest rates earlier to rein in the asset price boom, it would have depressed activity in the rest of the economy.

Sir John also raised questions over whether taxpayers would get back all of the money the government has now invested in the banking sector.

"There are some books: Northern Rock, Bradford & Bingley, which the taxpayer's now holding, which clearly have a level of defaults in them, [I'm] not quite sure how that will balance out against the residual of the capital," he said.

"As for the more mainstream banks, yes I think they've got a commercial future and I'm sure that in time they will... revive and start building and growing as commercial entities again."

Sir John, who was criticised by MPs on the Treasury Select Committee last autumn for failing to foresee the developing crisis at Northern Rock, said that the Bank was “learning lessons” from the current economic crisis.

He was appointed deputy governor of the Bank of England in January 2006 and is a member of the board of the Financial Services Authority (FSA).

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