King: 'no recovery till banks raise capital'

Sir Mervyn King Sir Mervyn has not painted a rosy picture

The governor of the Bank of England has given his starkest warning that banks in what he calls the advanced economies, including British banks, still have too little capital to absorb potential losses on bad loans. And he says that the economy will remain weak till they raise the needed capital.

Sir Mervyn King also made clear that he is implacably opposed to what has become known as "helicopter money", or the creation of new money by the Bank of England for writing off government debt, or funding tax cuts, or paying for public spending.

Although there is likely to be confirmation later this week that the UK economy is out of recession, the recovery remains anaemic, some four years after the great banking crisis that undermined global growth.

Sir Mervyn pointed out that the output of the British economy, or GDP, is 15% less than what it would have been if growth had been steady since 2007 - which (to simplify) implies that our incomes are 15% less than they would and should have been in the absence of the great financial shock of four years ago.

There has therefore been a great deal of agonising by those in positions to influence the economy, such as the chancellor, the chairman of the Financial Services Authority and the governor, about how economic momentum can be restored.

'Insufficient capital'

In a speech on Tuesday evening in Cardiff, Sir Mervyn makes two striking points about possible remedies.

First he says that the reason banks, including some British banks, have found it difficult and expensive to borrow, and therefore have found it impossible to provide the credit needed by households and businesses, in the right quantities and at the right price, is that they have "insufficient capital".

Sir Mervyn warns that "just as in 2008, there is a deep reluctance to admit the extent of the under-capitalisation of the banking system in many parts of the industrialised world".

The Bank of England has applied some sticking plaster to British banks, by launching two schemes - Funding for Lending and the Extended Collateral Term Repo - which are designed to provide cheap finance to banks, to compensate for investors reluctance to lend to banks.

But he says that Funding for Lending can be "only a temporary scheme". And he insists that the "window of opportunity it provides must be used to restore the capital position of the UK banking system".

Here is his stark and gloomy warning: "I am not sure that advanced economies in general will find it easy to get out of their current predicament without creditors acknowledging further likely losses, a significant writing down of asset values and recapitalisation of their financial systems."

He continues: "Only then will it be possible to return to a more normal provision of vital banking services so crucial to an economic recovery".

Losses fears

Sir Mervyn is fearful that we will repeat the mistakes of the 1930s in hoping that borrowers struggling to keep up the payments will one day be in a position to repay what they owe. Far better, he says, to turn off the life support for over-indebted businesses, households and even governments, write off the debts and start again.

Or to put it another way, the socially responsible behaviour of British banks in engaging in what is known as forbearance, by allowing overstretched debtors to take a holiday on payments, may now have become a burden on the economy as a whole - by keeping the banks in a state of permanent anxiety that one day they will incur huge losses on loans to these debtors.

Forcing our big banks to recognise all the big losses they are likely to face and raise enough capital to absorb those losses is the sine qua non, he says, of restoring the health of our banks so that they can provide the credit we need.

However, if that is Sir Mervyn's prescription for a sustainable economic recovery, he is scathing about those who argue that the Bank should write off some or all of the £375bn it is owed by the government, or should simply give money to the government to finance the gap between what the public sector spends and what it raises in taxes.

Both of these unconventional monetary policies are variations of the creation of "helicopter money" - which is styled in that way because economists see them as the equivalent of dropping free cash on all of us from a helicopter.

Sir Mervyn sees three fundamental reasons for eschewing helicopter money.

First, he says that if the Bank of England were to write off the gilts it has bought through quantitative easing, and thus cancels what the government owes, the Bank will have no gilts to sell to investors at the very moment when it may want to nudge up bond interest rates, and take the heat out of any incipient inflationary conditions.

Second, writing off these gilts would also leave the Bank of England with no income with which to pay commercial banks the interest they are due on their deposits at the Bank.

Candidate attack?

So at a time when the Bank wanted to push up the bank rate or interest rate on these "reserves" to stem inflation, the Bank would face a stark choice: it could become insolvent (which, to state the bloomin' obvious, would not be good); or it could create yet more new money to pay the interest to banks, which would be seen as debasing the value of sterling in a fundamental way, and could lead to hyper inflation.

Sir Mervyn says: "That is a road down which the Bank will not go and does not need to go".

For what it is worth, some may well see Sir Mervyn's attack on helicopter money as an attack on a candidate to succeed him as governor, Lord Turner, currently chairman of the Financial Services Authority.

But that is probably not quite right, because - as Sir Mervyn will know - while Lord Turner does believe that helicopter money is one of a number of unconventional policies that the authorities should consider, in the event that the economy doesn't recover, he has not made up his mind that helicopter money will turn out to be necessary.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 284.

    That is only a part of the problem. Further, building costs must be pared, the gravy train done away with, realistic property valuation instituted based on the insured rebuilding value, and principal debt cleared at accelerated rate. The entire market is shorted by every one and his mother because it plays so long.

    So say I.

  • rate this

    Comment number 283.

    The interest rate gravy train must end.

  • rate this

    Comment number 282.

    #279 startsmall - BoE defend value. That is what they do. They do it by maintaining liquidity. The problem Uk faced was dissolotion of the mechanism for providing liquidity, which is entrusted to the private banks and finance who actually create the money supply and had a magic moment. Or two.

  • rate this

    Comment number 281.

    This man was in charge well before the muck hit the fan in 2007/8. He is to retire on a £300k pa pension. If there is any justice in this world he should resign in disgrace and forgo at least the 15% of his pension which he says equates to the drop in potential GDP. He will also have RPI indexation so let that go as well. As DC said we are all in this together. First class to Euston please.

  • rate this

    Comment number 280.

    Where's old Writings gone? I nip out for the afternoon and he's ceased to exist again...

    The wise man knows the pen is mightier than the sword - the fool has heard this, unfortunately he chooses to write with disappearing ink.

  • rate this

    Comment number 279.

    there are 3.9 million interest free mortgages in UK.
    Let's say they are on average for £93,750
    am I right please check my maths..
    3.9 mill times £93,750 equals QE.

    are these the further likely losses?
    badgers for guv'nor and deputies
    then instead of badger baiting, we would have badger debating.

  • rate this

    Comment number 278.

    MK: "That is a road down which the Bank will not go and does not need to go".
    Me:"the A1, Kensington High Street. the one to hell paved with good intentions?"
    Prospective guv'nor candidates in asides to GO: " HIT THE TARMAC IN FOURTH GEAR, PETROLHEADS"

  • rate this

    Comment number 277.

    he doesn't want the bank of england to write off the 375 billion that the state owes it.
    Has he ever asked himself where the BOE got the power to print the money. Let me answer him. From the State. In other words the State owes itself 375 billion.

    This guy ran the bank of england ?

  • rate this

    Comment number 276.

    What Sir Merv says comes as no suprise it just took longer than it should have for him to say it.

    In recession last quarter out this quarter in again next quarter is called flatlining and nothing to get excited about.

    So far the BOE has been able to control this but for how long?

    Looking elsewhere the omens are not good.

  • rate this

    Comment number 275.

    The British economy didn't go South but went East. GDP increases will never come back voluntarily.

    1. Increase the supply of affordable housing and take the hit on having prices inline with real wages. Artificially propping up an asset bubble are creating long term damage.
    2. Change cultural buying behavior. Orientate towards buying U.K. goods or abstaining on purchases wherever possible.

  • rate this

    Comment number 274.

    I think Greece is more likely to have a military Junta,..and the Euro (they should have left the Euro many moons ago, IMHO).
    Dare say that may be an outcome but will be preceded by fighting.
    Euro - rather their lying politicians shouldn't have paid Goldman Sachs $4bn to lie about their readiness for the Euro.
    Not fussed about Scotland they can take their banks though.

  • rate this

    Comment number 273.


    I think Greece is more likely to have a military Junta, or to throw out the government and the Euro (they should have left the Euro many moons ago, IMHO).

    I guess the Greece voting, over the last two elections, maybe proves the old adage about the devil you know?

    Spain is more likely to split e.g. Catalonia but as with Scottish Independence, the sum of the parts and all that..

  • rate this

    Comment number 272.

    Several say house price are 2 high and they are for the following reasons

    1) this is an island there are limits to how many you can build and we have passed them for having a work/life balance environment reasons

    2) Breakdown in familes changing the size/type of houses required

    3) Immigration of 3_700_000 since 1997

    all of these issues need to be sorted out

  • rate this

    Comment number 271.


    Of course there is a case for change but without an alternative idea that predominates across society we are rather stuck. The current situation favours the majority for now. We can all go around looking for growth as if it was a lost kitten.

    This won't continue forever. The wheel will turn eventually and promptly fall off the cart. Then whoever is the most ready......

  • rate this

    Comment number 270.

    There is little difference between the 3 parties - sqaubble is pantomime stuff. GO called for us to be like Ireland in 2007. We are doing Japan right now - propping the banks makes it more likely!
    Growing manufacturing is not going to happen - see above. No doubt Cadburys will be off shored by then.
    Greece to have one, Spain to split peacefully is my punt.

  • rate this

    Comment number 269.


    I do not believe we will follow Japan's "borrow n spend" philosphy unless Moribund n Balls get back into power, in which case heaven help us all. The Coalition is trying to achieve the opposite.

    We most certainly won't have a growing manufacturing based economy but that was tongue in cheek, right?

    Civil wars in Southern Europe? nah.

    Let's exchange views again in 5-10 years.

  • rate this

    Comment number 268.

    Does the governor believe that some asset values are still too high?

    If so, why are the banks being encouraged to secure further lending against these assets until prices moderate to more realistic levels.

  • rate this

    Comment number 267.


    "All we need now is for them to put up their hands and plead mea culpa."

    Perhaps there's a case for change too?

    Seems the current policy is more, more, more! Because clearly we were too cautious before.

    There's no shortage of alternatives, some more radical than others. How long...?

  • rate this

    Comment number 266.

    For those which have no money at all I am truly sorry but for those that do, buy some gold, even at lofty levels - drip feed into it. It will not lie to you. In stark contrast, politicians and central bankers have trouble even walking in a straight line. If they can't inflate the debt away they will tax it away. At this point they are doing both. It is not called unconventional policy for nothing.

  • rate this

    Comment number 265.

    263.watriler "Is he hinting of credit crunch II?"

    We haven't really had CC1 yet. The whole policy basis of BoE/Treasury idiocy has been to avoid any form of CC. (hence zero int. rates - a 300 year low and QE.)

    At some point, as even King knows, interest rates have to revert to being prudential again or the whole of capitalism collapses. Till that happens the recovery cannot start!


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