The days of City “hubris” must come to an end, the Bank of England cautioned yesterday in an extraordinary attack by Mervyn King, the Governor, on excessive pay packages and heavy risk-taking.

Mr King said that the £50 billion bail-out extended to cash-strapped banks should not be seen as an opportunity to continue paying multimillion-pound bonuses to executives who gambled with other people’s money.

“Banks have come to realise in the recent crisis that they are paying the price for having designed compensation packages which provide incentives that are not, in the long run, in the interests of the banks themselves, and I would like to think that would change,” he told MPs. Mr King urged the financial sector to learn from its mistakes and not return to the “hubris and excessive lending” seen in the run up to the credit squeeze.

He told the Commons Treasury Select Committee that the £50 billion credit-crunch solution was not designed to help banks and mortgage companies to return to the days of 100 per cent lending and risk taking. It should eventually filter down to mean lower borrowing rates for consumers.

“We’re not doing this because we have an interest in the financial position of the banks as such, but their ability to finance growth in the rest of the economy,” he said.

The sector was also luring young workers with attractive salaries, according to Mr King. “I do think it is rather unattractive that so many young people, when contemplating careers, look at the compensation packages available in the City and think that these dominate almost any other type of career,” Mr King said.

He added: “When I look at the firms which impress me most, it’s not the large institutions in the City, it would be small and medium-sized firms and often private companies which are paid far less than people in the City.”

Mr King effectively dashed the Government’s hopes that the bail-out, announced last week, would break the mortgage deadlock and revive the housing market. In an embarrassing blow to the Chancellor, Mervyn King told MPs that government hopes that the funding lifeline would end the crippling mortgage drought were exaggerated.

Mr King said: “It \ is not designed to kickstart the mortgage market. This is designed to restore confidence in the banking system, not to regenerate any aspect of the mortgage market, or achieve anything else.”

With the Government under intense pressure over the economy, Mr King’s blunt comments will also embarrass Alistair Darling. Just a week ago the Chancellor said: “The idea behind it [the Bank's rescue plan] is that it . . . will begin the process of opening up the mortgage market, which will help householders.”

Last night a senior Bank of England official from its rate-setting committee called for drastic cuts in interest rates to stave off recession, and to prevent a drop in house prices of up to one third.

“We face a real risk that the UK may fall into recession, and aggressive action is required to prevent this from occurring,” Danny Blanchflower said in Edinburgh.

“The credit crunch is starting to hit, and hit hard. My biggest concern now is that the credit crisis will trigger a rapid downward spiral in activity.”

Professor Blanchflower appeared to be at odds with Mr King and other more hawkish members of the Bank’s Monetary Policy Committee. Yesterday Mr King told MPs: “We should not cry gloom and doom.”

He also dampened hopes of further cuts in interest rates soon, as he again sounded the alert over dangers from inflation.

Mr King conceded that tougher times lay ahead, predicting that the economy would be weaker for the next two years than it has been in the long-run. But he insisted: “That is not a disaster in itself.”

Fears that the credit crunch could turn the housing market downturn into a crash intensified yesterday as the Bank’s own figures showed that the number of new home loans approved in March tumbled to a near-record low, at 64,000.

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