Tuesday, November 25, 2008

It's Lending, Not Spending That's the Problem

Alex Barker reports on the FT website that Mervyn King thinks there will need to be a further financial injection into our banking system...
Appearing before the House of Commons Treasury select committee, Mr King praised the £20bn government stimulus package but warned the “single most pressing challenge” was to break the logjam in lending.

Well he's certainly right on the second part of his analysis. However, he needs to look a little closer to home, and the activities which the Bank of England plays a part in regulating, before calling for more government action.

RBS has attracted a lot of praise for apparently telling its customers that its lending policies and overdraft approval mechanisms remain unchanged. Indeed, I am told it sent a letter out to its branches last week making this clear. What did not get so much facility was a follow up letter the next day effectively making any new lending virtually impossible.

All the banks are indulging in a process of deleveraging the like of which we have never seen before. They are withdrawing from the risk market completely and relying on existing lending to make profits. If banks refuse to lend to companies with proven track records these companies run the risk of going under. If that starts to happen there will be a domino effect. So many people will lose their jobs that any amount of fiscal stimulus will have no effect whatsoever. Unemployed people cannot boost economic activity.

So if there is one thing the government really ought to be doing, it should address this issue with the banks as a matter of urgency. We were told this had happened last week, but their practices on new lending have not altered at all - in fact, in some cases lending has become far more stringent.

In tomorrow's debate, I hope the Conservatives will really push hard on this point.


Mr Jabberwock said...

One issue it seems to me with the current banking situation is that it seems too difficult to set up a new bank.

When the insurance market suffers catastrophe losses, yes rates go up but new capital quickly comes in and sets up new reinsurers; taking advantage of not having had to endure the losses others have suffered.

Should the BoE not make it clear that it would offer the same guarantees to a new bank entering the commercial market who could then lend to business unencumbered by the need to rebuild its recent losses by bleeding its existing small business customers dry

They could pick up a lot of good business quickly and would keep the others honest.

Just a thought.

Colin said...

Banks are quite rightly in the process of rebuilding their damaged balance sheets.

This is exactly what over leveraged individuals should be doing as well. We have the highest proportion of personal debt in the developed world as it is. Encouraging people to take on more debt is insanity.

John Woodman said...

I've not seen the following point widely discussed: the banks still have a problem financing themseleves cheaply because none of them are sure about the value of their existing assets. They need a process which establishes the value of those assets - it would probably have to involve international co-operation, and would be either an "I'll show you mine if you show me yours affair, or an auction or perhaps involving Governments buying toxic assets (as the US was about to do).

It seems to me that is where regulators should be focused, on isolating, explaining and then dealing with the degree of toxicity on bank balance sheets. Until there is full transparency about the problems any effort to solve bank funding and therefore lending will be inefficient because uncertainty costs money.

Also as far as the UK is concerned, the Government has not actually put any new capital into the banks yet (apart from those fully nationalised). It has just said it will.

Alex said...

The solution to the bank problem is to strip out all of the questionable assets into a separate vehicle (a bad bank as is often used in the US), and have the government fund that. What is left in each of the banks is in theory much more robust and hence the market regains confidence.

What we have at the moment is very opaque. The government shovels in cash, a bit like shovelling snow into a furnace, but has no idea whether all of the banks' losses have been reimbursed.

Theo Spark said...

You cannot lend money to people and companies who cannot afford to borrow any more. Until the present set of debt is paid off no-one is going to borrow more. There again the banks are dumb enough to lend more money on the basis that if it goes bad the government will bail them out. Spoke to a liquidator today and his business has gone up 40% in a month.

Doug said...

I don't agree with Iain. Put simply what is/was all this lending used for? Spending (for the most part). Spending is very much at the root of our problems. We'd all love to spend money and build a strong economy but not if it is based on borrowing. It is an awful Catch 22 we're in. But I'd prefer to see low to moderate spending with a greater priority on retiring personal debt. It has to been done sooner rather than later.

Scary Biscuits said...

Imagine you're driving an old fashioned car. It has lots of guages and dials measuring things like oil pressure, temperature, water and voltage. First, the oil pressure went; then the water temperature; then the voltage; then they all went haywire. Then the engine started making noises and now smoke is coming from the engine. Everybody agrees, however, that the problem started with the instrument dials. Madness!

Blaming the current crisis on banks is like blaming the guages when your car breaks down. Clearly the solution isn't simply to change the way the guages work! We need to fix the engine components, the reality that caused the bad measurements, instead.

Likewise, the financial crisis is neither lending nor spending. It is not any financial metric or any combination. All these things are merely guages, instruments that we use to measure reality.

The problem is fundamental: that as a country we are consuming more than we earn and we have been for ages. Lending to make up the short fall becomes increasingly difficult especially if the time it gives you isn't used to correct your underlying behaviour.

Nobody in politics is addressing this underlying issue. Nobody wants to tell the people of Britain they've been living beyond their means; that the oasis of ever greater consumption and less work was just a mirage.

Andy in Newcastle said...

As with any business, the banks have the right (indeed, a duty) to ensure that they are trading in an economically viable way. That means that they must lend in a more sensible and sustainable manner, which has often not been the case in the past.

However, if it is the case that changes in the banks' lending practices are having a detrimental effect on the wider economy, then the Government should intervene in an appropriate manner. After all, this Government has not usually been backwards in coming forwards when it comes to bossing people about!

It's worth adding, however, that the need for debt levels to be kept at a reasonable level applies to the state as well as private individuals. I would therefore suggest that some of the Government's less economically productive social engineering projects should be knocked on the head once we come out of the recession. That should help reduce the need to increase taxes.

Man in a Shed said...

If you want to bypass the banks, and your a private individual then there are social lending alternatives like zopa.

But on a more general point the part of the current crisis which has received least attention is who was providing the money which allowed the debt bubble to take hold and where the money has withdrawn to ( it has to have gone somewhere ).

Odd that we hardly ever hear of this on TV / in the papers.

Infoholic UK said...

If the Government really want banks to lend more, why did they insist on INCREASING the capital they are required to hold, when the conditions for raising capital are the worst in history ? Surely not to force them into the loving embrace of the state ? They wouldn't do that...would they ?

Look at the Barclays meeting yesterday - the shareholders bitched, but ultimately they voted it through 'cos better to give away a stack of money now, than watch Darling and Brown slowly kill them off over the next 18 months.

The banks who are taking the money are therefore hoarding all their cash to a) stay within the capital requirement and b) pay off the taxpayer ASAP. That's good, right ?

The public (and the goverment) needs to make its mind up as to what it wants, because it's trying to have it both ways at the moment - the banks can either make profits and give the money back or lend to all and sundry and risk never doing so.

Raedwald said...

The banks ARE trying to lend - but to the wrong people. Sorting through today's junk mail, I have 2 "You've been pre-approved, just sign online and the money's yours straight away" offers; one from a Citigroup subsidiary offering me £30k over 5 years at 11.99% and one for a lesser amount for a slightly higher interest rate from another big 5 bank.

I'd rather pierce my eyeballs with hot needles than take a bank loan out at the moment; I don't need to, I don't want to and even if I did, with inflation set to fall to zero and the Bank rate to 2.5%, I'd be looking for a much more competitive deal than either of these.

It's the old story - banks are always happy to lend to those that don't need it, but run from those that do.

Folk like moi still with AA credit ratings and tons of equity left in our homes didn't get where we are today by being feckless, and aren't about to blow it. Our instinct is to save, not borrow; to buy gold, to fill our pantries and store cupboards with tins and packets, stock up on candles and solid fuel and slow the circulation of (our) money as far as possible.

The banks are faced with a dilemma - increase lending to B and C risk punters at competitive rates (i.e. what got them into the mess in the first place) or to sit on piles of cash not earning anything at all.

It all seems a bit Catch 22 to me.

tory boys never grow up said...

And if the money were lent what do you think the borrowers would do with it? Both lending and spending are important - and you really are just engaged in the political equivalent of a chicken or egg debate.

evil g said...

Labour is too busy wanting to be seen to "do something" to sort out the boring matter of the banking crisis.

You'd have to be a damn fool to think that a 2.5% temporary cut in VAT will improve anything.

CityUnslicker said...

@ Doug and others.

Corporates need to borrow to roll-over existing debts that they are paying off. This is why it is so important.

Imagine you fix your mortgage for 2 years. After 2 years you would normally swap to a new product to get a better rate.

What is happening now in the corporate world is that instead of the swap, banks are asking for the mortgage to be repaid in full. Could you repay your mortgage after 2 years?

No, this is the problem. The banks need more cash so that they do not have to behave in this way. Or my suggestion is that we have some new banks, not crippled by toxic loan books.

neil craig said...

If the problem is, as politicians have repeatedly said, that banks have been irresponsible in lending so many multiples of their reserves then the way to build such reserves is by lending out a bit less. We cannot have it both ways. Having it both ways is what got us here.