Have regulators deepened the recession?

 
bank of england

Talking of the possible need for even more unconventional economic policies (as Adair Turner has been doing), to ward off the risk of the UK economy turning Japanese and stagnating for decades, something pretty odd and unconventional has been happening in the regulation of banks, for just that reason.

In the last few weeks, the soon-to-be-disbanded Financial Services Authority has told banks that any extra lending they make to the UK economy - to businesses and households - can be provided without incurring any additional capital charge. Which in theory should significantly reduce the costs for banks of lending.

And the FSA is also allowing banks to hold a much wider and more diverse and riskier collection of supposedly liquid investments, as a proxy for cash, which is their rainy-day money in case too many of their depositors want their cash back at the same time (it is the insurance against bank runs).

That also represents a significant cut for banks in the cost for them of doing business, because the safest liquid investments - such as government bonds - pay the lowest income.

A bit of translation may be in order.

As you know, banks have to hold capital to absorb potential losses when they lend. And one of the big causes of the great crash of 2007-8 is that over 30 years - due in part to appalling regulation - banks were allowed to reduce their capital reserves to a tiny fraction of their massive loans and investments.

Which is why when the bust came, taxpayers and not just shareholders incurred massive costs, bailing out the banking system.

So in a huge global financial manifestation of an enormous barn door being closed long after all the horses have vanished from sight, banks since 2008 have been forced by regulators all over the world to hold more capital, relative to the loans and investments they make.

Many would say closing that barn door was inevitable and rational. The British government's finances, for one, could not withstand another calamity on the scale of what we have just suffered.

But capital is expensive for banks to raise - because it is the money that is (in theory) most in danger of being lost when times are hard.

So banks have an incentive to keep to a minimum their ratios of capital to loans (or assets). And when they are ordered to boost their capital ratios, there is the paradoxical consequence that they will tend to lend less - which in turn leads to an economic slowdown, which in turn means that their customers have more difficulty repaying their debts, which in turn weakens banks.

So we find ourselves - as Lord Turner more or less admitted last night - trapped in a nightmare where trying to do the right thing to strengthen banks has the paradoxical and wrong outcome of undermining economic recovery and further debilitating the banks.

Or to use the dreadful jargon, forcing banks to hold more capital can accelerate the process of deleveraging (paying off debts). Deleveraging is necessary after a borrowing binge of the sort that took place in the UK, US and much of western Europe in the years before the crash, but it can savagely undermine prosperity if it happens too fast.

Anyway it may well be many years before we have a clear view of whether the regulators who permitted banks to hold far too little capital during the boom have subsequently moved too fast or too slowly in forcing them to raise more capital subsequently.

What's fascinating is that the FSA has more or less admitted that it thinks that it may have been too zealous in the way it forced banks to build their capital reserves - or at least it has in a way, because the banks would say (in fact they do say) that the FSA is still facing in two directions.

Brief interlude: I should point out that the FSA is not the independent boss of its own actions any longer. It is being wound up, and the relevant bit of it for our purposes is merging with the Bank of England; and right now the FSA is acting under de facto instruction from the Bank of England's "interim" Financial Policy Committee (FPC), which next year will become the formal boss of all this prudential stuff when it is given statutory authority.

Here is the thing.

With the encouragement of the FPC, the FSA has (as I've mentioned) told banks that if they make incremental loans to British businesses and households as measured by the Bank of England, they can do so by running down the buffers of capital they have built up (or to put it another way, they don't have to raise any new capital for this lending).

Now some have characterised this as the banks being able to lend under the Bank of England's new Funding for Lending Scheme, free of capital charge. But that is incorrect. Because HSBC, which is not taking advantage of Funding for Lending, can also lend incrementally without setting aside extra capital.

The important point, to repeat, is that this should make it cheaper and easier for the banks to lend.

Except for one thing.

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This may be one of those rare occasions where... it is possible to feel a degree of sympathy for bankers”

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The FPC has also said that it wants banks to become more resilient by building up even more capital, particularly because it believes there is a serious danger of the eurozone dissolving in a chaotic way that would wreak havoc for banks.

"You what?" you might be tempted to exclaim. "What on earth is going on? How can the FPC and the FSA say - on the one hand - that banks can reduce their capital ratios by lending more to the British economy and simultaneously say that banks have to become more resilient by holding even more capital and liquid assets?"

This may be one of those rare occasions where, however unfashionable it may be, it is possible to feel a degree of sympathy for bankers, because they may feel the regulators who boss them around are sending them somewhat confusing signals.

As you would expect, I have asked the regulators what drugs they are taking. And here is their answer.

First, that there is a timing issue here. They will be more lenient on capital ratios while the economy is particularly anaemic, as it is now, but in the longer term they would expect banks to take further steps to rebuild capital.

Second, there is an issue of priorities for the banks. The regulators will indulge banks that want to reduce capital ratios by lending more, but not banks that wish to eat into capital resources by paying big bonuses or dividends.

Third, and this made me smile, they accept that they may have presented these conflicting messages in a manner that is not as clear as they might have liked.

So there we have it.

Banks can hold less capital today and must hold more again tomorrow. Which may represent better news for those who want to borrow from them.

But it's bloomin' awful for bank shareholders and bank executives - because it means dividends and bonuses will remain under intense downward pressure (don't dchuckle, that's really unworthy).

 
Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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  • rate this
    0

    Comment number 261.

    www.cml.org.uk/cml/media/press/2992
    www.propertylive.co.uk/property-news/uk+property+news+average+ltv+ratio+revealed/800695048
    www.fsa.gov.uk/library/other_publications/statistics
    www.bankofengland.co.uk/publications/Documents/other/monetary/trendsjanuary12.pdf
    http://www.mortgagestrategy.co.uk/housing-market/average-ltv-in-scotland-at-three-year-high/1046794.article

  • rate this
    0

    Comment number 260.

    http://www.guardian.co.uk/money/2012/oct/04/house-prices-fall-third-consecutive-month

    "House prices fall for third consecutive month

    Figures from mortgage lender Halifax show a 0.4% monthly decline, a 0.5% quarterly decline and a 1.2% annual decline"

    ""in the face of limited market activity, still low and fragile consumer confidence, and muted earnings growth".

  • rate this
    0

    Comment number 259.

    Onward-ho: "Most mortgages now have 25% equity and so are low risk."

    If true(source please),and based on current stagnant/decreasing prices and rapidly deteriorating employment conditions.

    No more Great Ponzi onward-ho,accept it.

  • rate this
    0

    Comment number 258.

    Most mortgages now have 25% equity or more and so are low risk. And hardly any are interest only so things can only get better as far as future-proofing is concerned.And given that low interest rates and inflation seem to be carrying on, an uplift in house prices would be a logical consequence which would make land and buildings worthy of redevelopment. Let's invite the builders back !

  • rate this
    0

    Comment number 257.

    Deja Vu. Went into my local Barclays, home of such useless financial instuments as "pingit" and asked for a loan to consolidate a couple of credit cards. They wouldn't do it at 12%, but they pointed me in the direction of another lender 17%. Ok I'm better off per month. I asked what happened to the money hmg had given them to give to us, she said the men in london would lend if I had money.

  • rate this
    0

    Comment number 256.

    @250.Little_Old_Me
    "I take it you do realise that he wasn't at the FSA when the credit crunch/banking crisis happened...???"

    Hmm, he was savvy enough to jump ship from his position as vice Chairman of Merrill Lynch Europe before the excrement struck the forced air convection device:
    http://www.guardian.co.uk/business/2007/oct/25/useconomy.us

  • rate this
    0

    Comment number 255.

    One cause of our current crisis was the banks offering easy mortgages to people who could not pay it back. Another cause was people taking those mortgages, failing to pay them back and refusing to move out.
    We are all in this together and all have some level of responsibility. Behaving like victims and forever blaming someone else is not the solution.

  • rate this
    0

    Comment number 254.

    DEAR BBC MODERATORS / BLOG STAFF

    I'm not shouting - just trying to catch your eye!

    I note Robert's new post has no facility to post comments.

    Is that an accident / tech problem, or a change of policy?

    It would be nice to tell regular readers/posters whichever way.

  • rate this
    +3

    Comment number 253.

    First realise that bankers are the problem.

    They skim just about everything productive people do.
    Then realise they claim to be essential.
    Then realise how myriads of us have become dependent upon their skimming activities.

    Then work out how, on a global basis, we simply have to get rid of them.

    You know it makes sense.

    So when do we do it?
    How do we do it?

    So lets get started.

    Bretton Woods

  • rate this
    +3

    Comment number 252.

    We hear a lot about "structural problems" with economies.

    That always translates as "workers having rights".

    It seems to me more serious that we have structural corruption. Politicians will not regulate those who support their parties, or provide revenues in good times for popular policies, enabling them to keep power. Pension law channels people's savings into the wrong hands as stake money

  • rate this
    0

    Comment number 251.

    There is a much easier (and ethical!) way to do this "helicopter drop". Simply announce a tax holiday, i.e. no employee income tax for a year (or smtg. along this line).

    How much does HMRC take in in employee income tax (just tax, ignore NI and whatever) annually? How much spent for QE?

    I've said this since QE1. It will eventually happen.

  • rate this
    0

    Comment number 250.

    249.Golden Bear - "Lord Turner is a joke! As the head of the FSA, his failings are obvious and clear cut. If he gets into the BoE..... GOD HELP US!"


    I take it you do realise that he wasn't at the FSA when the credit crunch/banking crisis happened...???

  • rate this
    -1

    Comment number 249.

    Lord Turner is a joke! As the head of the FSA, his failings are obvious and clear cut. If he gets into the BoE..... GOD HELP US!

  • rate this
    +1

    Comment number 248.

    247.Wiz

    The Europen debt situation was caused by the banking indisutry going so tits up it had to be balied out (80% of UK Govt debt was the bail out).

    Higher capital ratios will ensure that the banks can withstand future assaults from dodgy lending that goes wrong.

    There is every escaping diaster, just so long as we let up on the austerity that is making the debt BIGGER, not smaller....

  • rate this
    0

    Comment number 247.

    The baffling part of this story is that the purpose of these bigger capital holdings is apparently to ward off a European debt disaster prompted by the collapse of the Euro. There already is a European debt disaster and it is not going to be warded off by higher capital holdings. The banks are in serious trouble now, and will be in more serious trouble tomorrow. There is no escaping the disaster.

  • rate this
    0

    Comment number 246.

    #242 and another thing , lots of people wont spend it they will try save it,and how do you know they will spend it in the uk.........you must be mervyn king , hes about as daft as that.

  • rate this
    +1

    Comment number 245.

    #242 bad idea it would have been a disaster to give everybody £45000 inflation would shoot up, if i was selling a service and i knew everybody was loaded id wack my prices up...its human nature...dont you people know anything.printing £325 billion is a shocking idea no matter who it goes to.

  • rate this
    +3

    Comment number 244.

    Robert finally gets it !
    We need banks lending more , and even governments spending more.The crash is more unsustainable than the boom.
    Suddenly Gordon looks smarter than ever.

  • rate this
    +2

    Comment number 243.

    Sorry, bad math, to correct my earlier post @242. It would have put roughly £5400.00 to each and every person in the UK, if population is at 60 million.

  • rate this
    +3

    Comment number 242.

    If the BoE had given the £325 billion to the people, instead of the privately run banks, the economy would have bounced back. It would have put around £ 45,000 to each and every person in the country.
    The money belongs to the people, not privately owned and run banks....
    Write about that Mr Peston.

 

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