Regulating banks so we do get an economic recovery

The politics of bashing banks is good. They are widely blamed for the last collapse. The people who regulated them, and the Central Banks who set interest rates and rushed from boom to bust with the money supply have escaped much of the blame. Many of the commercial banks’ Directors and senior executives earned too much money for most people’s stomachs, and then had the temerity to carry on paying themselves bonuses after the crash. Some banks profits have roared back strongly after the losses of 2008-9, whilst taxpayers remain sandbagged by the worst debts.

Against such a mood and armed with such lopsided analysis it is popular for governments to demand controls on bonuses, taxes on profits, and require banks to hold more cash and capital. The first of these does not seem to work, the second will reduce banks cash flow as they try to rebuild their cash and capital positions, and the third will cut their lending.

The sad truth is, whether the politicians hate them or loathe them, we need the banks and we need them to finance a recovery. Some bloggers say they do not want more credit to be extended. I have to tell them, without more credit there will be little growth and fewer new jobs. Some critics say businesses do not want to borrow more money, because they do not enjoy the demand for their products. They should note just how strong growth is elsewhere in the world, and how there are already shortages of product at home in the UK early in the cycle. We do need UK business to make more here to susbtitute for imports,and to export to faster growing countries. That requires working capital and investment finance.

The world’s governments and regulators genuflect to the idea that they should switch from pro cyclical regulation to counter cyclical regulation. They now accept, looking back, that in the upswing in 2005-7 they reinforced the credit boom by relaxing controls, and in the downswing, 2007-9, they reinforced the fall by being tougher. So why can’t they now agree that this is still somewhere near the bottom of the cycle? Isn’t this the time to say we have done enough to rebuild the cash and capital of most banks? The UK Tier One ratios now average around 12%, well above the levels of 2006-7, and good enough for the first phase of the upswing.

The sad truth is governments have to allow banks to make more profit to rebuild their reserves and pay off past losses. It will not make either the banks or the governments popular, as people resent bank charges and interest rate premia. It is however essential to get a well financed recovery. If we had more competition in the UK banking the charges would be lower and the costs better controlled. A lack of sufficient competition leads to high bonuses and high salaries.

It’s time for regulators to say, job done for the time being. They should look again at the adequacy of cash and capital once we’ve had some growth.


  1. Lindsay McDougall
    July 4, 2010

    It's perfectly simple. Don't regulate them at all and don't bail them out. Don't impose any special taxes. Insist on all the money "borrowed" from the taxpayer being paid back with interest. By all means negotiate the schedule of repayments and accept proceeds from asset sales.

    And if necessary, tell the EU and the IMF to take a running jump.

  2. waramess
    July 4, 2010

    ",,, we need the banks and we need them to finance a recovery."

    Only a politician seeking an instant solution could utter such words.

    What sort of recovery do you want to see? Gordon Brown spent thirteen years constructing the bubble and you would see it reflated iin six months or so?

    First we need a recovery otherwise there is nothing for the banks to finance. The banks are certainly not going to cause the recovery so the problem of reconstructing the banks can, in the meantime, continue.

    Reducing the burden placed on corporates will be an important part of the process as will reducing the burden of taxation on the electorate. Fine words are a good start but the reduction of the tax burden will only manifest itself with time.

    Politicians and Government should take care to remember that they are the problem, not the solution, and they must repent before a meaningful recovery can proceed.

    Of course, should this be too much to ask, another bubble might do the trick

    1. Lola
      July 5, 2010

      "First we need a recovery otherwise there is nothing for the banks to finance. The banks are certainly not going to cause the recovery so the problem of reconstructing the banks can, in the meantime, continue.

      Wrong. I have two opportunities that I want to pursue. I wnat to develop my existing business and I have an opportunity to take my business model elsewhere. For the former I need very little, just a flexible attitude to short term o/d facilities as it is self funding very quickly, but our bank has no money to lend and is being completely unhlepful at all as well as charging eye watering rates of interest at up to 7% over base. In regards to the latter I need a largeish capital sum, but I have no chance with the banks – they haven't got any loose money. So I am exploring priavate finance. In trust I am happier doing that as the banks are utterly untrustworthy. Both of these enterprises will create real wealth and real jobs and will help drive the recovery, but without finance they won't do that.

  3. Geoff not Hoon
    July 4, 2010

    Mr. Redwood, like me you are old enough to remember the secondary banking crisis several decades ago. The result was a decision to require 'stronger' banks to prevent it happening again. Sadly that created the monsters we have today. You quite rightly ask for more competition but in reality I believe we will see a major decline in UK Building Socities in the next 5-10 years as the big banks decide rather than compete for savers money they will put them out of business with cheaper mortgages. Simple economics says what will happen after the number of Building Socities has halved or worse.

  4. Norman
    July 4, 2010

    Slightly off topic but I'd welcome it if the government offered us taxpayers reduced price shares in the banks (I believe the idea has been mooted). After all, we've propped the share price up for over a year now, let's 'share in the proceeds of growth' the good old fashioned way – making profits.

  5. christina sarginson
    July 4, 2010

    Years ago John many of the public supported the banks and anyone working in them had a good job and was well respected now they have disgraced themselves by being greedy and risking too much. I have no problem with the banks making a profit but do have a problem with paying so much for any loans I have through my business. I do need them to loan more money but at a rate that is affordable for all and ensuring that the profits go back into the country and not their wallets.

  6. Jeff
    July 4, 2010

    There is as usual a lot of sense in what you say. We do need the banks. But do we need the same people running them? There have been no negative personal consequences for most of those bankers whose actions have brought us to where we are now. They are still in charge of the same banks or running the same spiv type operations. I know the government has commissioned a report on the banking industry, but that won't conclude until next year. One suspects that the fitness of those currently running banks to continue to do so will not be among the points considered. Greed and a calculated disregard for the all too obvious outcome were widespread. These people are not the fit and proper persons we need to run such an important business. Should not government support for these banks be conditional upon these discredited people leaving the business.

    At a time when everyone else has been or will be required to make big sacrifices, ordinary people will naturally ask themselves why they are being asked to do so. When people see that the banks are continuing on as before, many will conclude that these sacrifices are asked of us just to support an avaricious "elite". Many on the political left are making this point already and of course they also automatically include nasty evil Tories in the mix.

    I do believe that we should take vigorous measures to put our countries finances back in order. However it is very hard to make the case to other people when we just seem to be setting Britians worst bankers up again, just so that they can lead us into another calamity.

    Change the bankers, ensure the banks are small enough to be allowed to fail. Then the new austerity may be worthwhile. If we are indeed all in this together, "we" must include the banks.

  7. Brett Hayter
    July 4, 2010

    Mr Redwood, surely you would agree that the issue facing the world economy at the moment is a lack of demand and a large amount of uncertaintey.

    There can be very little increase in demand from consumers given the state of household balance sheets, if anything a rise in saving ratios to historical norms is appropriate, in which case spending will remain low.

    Corporations as much as they bemoan a lack of credit are actually suffering far more from the uncertainty and weak demand. There should be a distinction made between large and small businesses. This week's Economist highlights that large corporates are hoarding cash, which would indicate that it is the demand outlook which constrains their investment. (In part in the US this is due to the current administration's disdaine for enterprise and lack of respect for property rights in cases such as Chrystler's secured creditors).

  8. Brett Hayter
    July 4, 2010

    Smaller businesses face the same uncertainty, however they are under capitalised, and the notion that it is a lack of credit that is the problem is only a half truth, they also lack equity capital. Over the last decade small business balance sheets have looked more unhealthy as businesses have started to rely on banks providing working capital and financing inventory. Surely the right measure in this case would be to increase depreciation allowances and cut capital gains tax?

    1. Lola
      July 5, 2010

      Agreed generally. Small business and in particular micro business has no access to the global capital markets so we can only raise money from (a) the banks, (b) our own resources (c) angels and friends.

  9. John Hatch
    July 5, 2010

    The brutal truth is that the banks' employees gambled away their shareholders' money and for several years produced wrong accounts that disguised that fact. It will take a generation or more to restore the lost share capital; but the government has hoped that printing money will help. Mr. Brown taxed those illusory profits to add one million employees to the state sector; and both the banks and the government also lavished money on I.T. projects. They also fell prey to recruitment consultants who went round talking up the salaries of senior managers across the large corporate and public sectors on spurious grounds of comparability. Simultaneously, most large organisations (and, now, even charities) have been infected with 'equality and diversity' dogma and the new religion of 'person-made' climate change.

    Pantomime squawking about some marginal reductions in some areas of public spending, while the total continues to increase, shows a failure to grasp the gravity of this country's situation and dire prospects. Or, in the case of our internal enemies who have determined to destroy our previous way of life, continued malice and mischief.

    1. simon
      July 5, 2010

      Completely agree with what you say about banks illusory profits and Gordon Brown turning a blind eye so long as they were giving him money to waste .

      The banks have historically attracted the cream of U.K. software experts .

      The public sector I.T. projects could have given a very good return on investment if they had been properly managed .

      A luddite attitude to I.T. projects is akin to throwing the baby out with the bathwater and will drive another nail into the coffin of what is left of the U.K.'s once healthy software industry .

  10. Andrew gately
    July 5, 2010

    I think you are on the right track with this article John, unfortunately as you will see from the comments above people are more interested in moaning about stategic or tactical issues relating to banks rather than the strategic issues facing the economy.

    Despite Alastair Darling announcing in the budget that the bank bail out has provided 8 billion into the treasury coffers there is still a myth being peddled that the reason why the govt. has a deficit is because this is money used to bail out the banks. Peter Hain said as much on Question Time recently and it was unchallenged.

  11. Mark
    July 7, 2010

    The EU's new bank bonus regulations are no panacea. They simply provide an incentive to manipulate the banks' share prices by the timing of the recognition of profits and losses from the "cookie jar". Of course, the EU daren't admit that continental banks are in trouble mainly because of slack accounting by the EU/ECB itself, which failed to admit that the Stability Pact was being ignored.

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