How much more capital do the banks need?


                      As a critic of the regulators in 2006-7 I said the banks should be made to hold more capital. In those days they were too heavily geared. The banks were allowed to lend far too much money with far too little capital to pay the losses if some of the loans went wrong.

                       The Regulators said the world had developed a new paradigm. Long words often conceal sloppy thinking. The world of banking, they argued, had become so much better at managing risks. Because the banks were bigger and global in many cases, they could take on much more risk. Subsequently they discovered that more risks meant more problems. All the risks could go wrong together. Spreading risk did not necessarily equal reducing or managing  risk.

                    Now the Regulators argue the opposite. They believe that banks needs huge quantities of capital to back up loans, as they think many loans can go wrong. They add to the confusion by regarding loans to governments as risk free, at a time when they are about to learn the hard way that loans to government also carry substantial risks. The regulators have regulated the commercial banks into too much sovereign debt risk at the wrong time, whilst discouraging private sector risk at a time when we need more loans to power recovery.

               Making banks hold more capital does two things.  It lowers their profitability, and it means they lend less. That would have been a great thing to do in 2006-7 when things were getting out of hand. It is an odd thing to do when the banks need to rebuild their balance sheets and when good risks go unfinanced in the economy.

                Regulators now say they need to hold more capital to pay the losses that are all too likely on the loans. It is true that banks may still have to pay for large losses on loans made in the heady days of 2006-7.  The fear for the nationalised Irish banks is that they may lose many billions more on property values that have been badly hit by the crash.

                What we need from here is patient and better management of the bad generation of loans made prior to the Credit Crunch, allied to more loans for businesses and properties now, in the post crash enivronment. By definition values are now a lot lower and the risks on future loans therefore diminished.

                  Banks need to be profitable to get out of this mess. Economies need to grow to get out of this mess. If the alleged remedy for the ill is just more capital it will restrict or stifle growth. That in turn means less profits and fewer loans, which in turn makes it more difficult for the banks to be nursed back to health.

                The Regulators thought they had created a perpetual motion prosperity machine when they turned a blind eye to excessive lending and asset price inflation before the crash. Bankers loved the freedom the Regulators gave them to write more loans and book more bonuses. They need to be careful they now do not create a perpetual motion misery machine which keeps asset values low or falling, which prevents enough new loans and business, and makes it impossible for the banks and the economies to trade themselves out of the mire.

            The recent decision to increase banking capital in Ireland by E24 billion, taking it to a total of E70 billion and the effective nationalisation of the major banks, shows how expensive this policy and past mistakes can prove. These are huge sums for a small country. All this debt is a burden on Irish people for many years to come.

           Meanwhile it is important that the UK does not make any contribution to future Euro area bail outs. The policy is questionable as an approach anyway. It is quite wrong for the Uk to make loans to a system it rightly stayed out of. Lending money to countries which cannot grow owing to a high exchange rate, high taxes and spending cuts is not a great idea.


  1. lifelogic
    April 2, 2011

    It seem clear that the UK will indeed be contributing to these ill conceived Euro bail outs. It is also very clear that banks including government owned ones are drawing back lending even from good borrowers and restricting lending to new ones for little reason to do with credit risk.

    This is crippling growth and costing vast numbers of jobs.

    Regulations at the moment are making lending too tight we need more competition in lending and more lending to the many good customers unable to borrow.

    1. lifelogic
      April 2, 2011

      An impression (perhaps created by the BBC) of cuts too fast too deep when we have in fact too little too late is the worst of all. The reverse of this is what is actually needed.

      It is no good asking the public what they want . They want what will work. If you are designing a plane you would not ask the public for suggestions as to wing and engine design detail and blame them when it crashed. Cameron need to implement cuts that will work now to bring the economy round by the election. Not talk about cuts but fail to make them that is the worst of all worlds.

    2. lifelogic
      April 3, 2011

      Much of the banking problem (as with the earlier Lloyds Insurance racket) is due to the selling or worthless pieces of paper. If you can create a piece of paper, with a perceived value, then a whole industry will develop to market, value, promote and reassure buyers of that worthless paper. All will profit very well until the music stops.

      Far better to buy or lend on real assets plant, buildings, machinery, businesses and loans secured on these real assets. Paper is, after all, just paper even if it is beautifully printed and presented and certified by several august and esteemed bodies.

  2. Alte Fritz
    April 2, 2011

    As an outsider from banking, it is unclear who drives the regulators now. Is the drive to increase capital ratios EU driven? Is it evidence of a herd mentality in regulators?? How are other,especially EU members, approaching it?

    Perhaps I ought to make abigger effort to find out, but these important questions are barely aired in day to day news coverage.

    By the way, whenever you hear anyone speak of paradigms, make sure your wallet is still there. Paradigm would have found a place in Beachcomber’s ‘Dictionary for Today’.

  3. Radders
    April 2, 2011

    Of the $500 trillion in derivatives around the globe in 2008, it’s estimated that the UK’s share of ‘worthless’ derivatives, once all the trades have been collapsed back, is something in the region of £10 trillion. There are only three ways to get rid of those toxic liabilities – write them off, inflate them away or default.

    Wishing against reason that the paltry sums in bail-out money and inflation at 5% will make any meaningful inroads into the liability is the triumph of hope over experience. All our billions have done is keep the banks on life-support by maintaining share values from collapse. I fear we would have been better off biting the bullet back in 2008.

    1. acorn
      April 2, 2011

      Radders. You have to wonder what the Banks’ Auditors were doing before the crunch hit. We must now assume that “Auditors Opinion” on any set of accounts is valueless. Which bit of “going concern” did they not understand.

      The crunch did highlight the fact that Financial Services Authority and the Financial Reporting Council were the two most useless Quangos ever invented. These two, so called independent, bodies; were so independent they were on another planet. (The FRC had a major clear-out of dead wood last year; which tells you something. The old set of Quangocrats was replaced by a new set of Quangocrats).

    2. Simon
      April 2, 2011

      I think you are right Radders .

      I fail to see any social benefit in instruments like synthetic credit default swaps . It’s like watching a neighbour driving like a psychopath and half the street taking out individual insurance policies on his or her car .

      The idea that the taxpayer is the counterparty (where losses are concerned) is abhorent .

      Most definitely should all have been declared null and void by international agreement . It’s scandalous that ordinary men , women and let us not forget children have been ensnared by debt on a very , very spurious basis .

      At minimum you would have thought that British banks should have been prevented from writing any new synthetic derivatives but they are still , including the tax payer bailed out banks , taking on new business of this sort .

  4. alan jutson
    April 2, 2011

    I think things will get worse before they get better.

    I fear the toxic debts are worse than anyone has yet calculated.

    I hope I am wrong.

    No to more EU bailouts.

    Face facts, we are/have run out of money.

    What is the sense of us borrowing more, to lend to someone in a worse position.

    1. Simon
      April 2, 2011

      There is only one place the money is going to come from ; whether it be to pay bank losses , create bank profits , pay banker bonuses or bank corporation tax .

      The whole relationship between the banks and the real economy has been turned on it’s head .

      What has changed in the last three years ?

      Not one bank has been broken up so that it is not too big to fail – which is the only regulation worth a damn .

      The banks have successfully resisted the reinstatement of glass-steagal type seperation between retail banking and riskier activities which served so well for many years .

  5. Iain Gill
    April 2, 2011

    some key things for me

    allow new entrants to the market and get rid of many of the current delays from regulators to that happening

    keep banks smaller on average so that they can be allowed to fail

    guarantee deposits not the banks themselves

    let banks go bust, thats the best way of forcing them to improve their risk measures

  6. English Pensioner
    April 2, 2011

    As a retired engineer, I have considerable difficulty in understanding what’s going on because it is way outside my field of expertise; the trouble is, I get the impression that those in charge, particularly in the EU don’t have much idea either, and are simply plucking figures out of thin air!
    In my mind, I try to simplify matters to a personal level.
    The regulators say that the banks need more capital to back up loans. Does this mean that if I lend my daughter £1000, I should have another £1000 in the bank in case she doesn’t pay it back? I don’t see how this would help me.
    I have some money in a Building Society which I keep for emergencies (earning minimal interest), and I would decide if a family emergency justifies its use. In the case of the banks, are the regulators saying that these huge sums of money just going to sit in their vaults doing nothing, just in case of emergencies? Then who decides if it is an emergency, the Bank or the regulators?
    To me, the whole crisis was caused by stupidity on the part of the banks. Loans of 120% and such like, frequently to people with no steady income, were based on the assumption that house prices would rise. But, the whole concept was fallacious as houses don’t have any intrinsic value, they are worth no more than someone is prepared to pay for them, and this in turn relies on the banks giving even bigger loans to the next person to keep the prices rising. I still can’t see how huge amounts of money will stop this stupidity!
    But as I said, I’m an engineer, and the common sense and logic of engineering doesn’t seem to apply to banks!

    Reply: the aim of more capital is to have money from shareholders available to pay for losses when loans go wrong. Better still is not to lsoe the money in the first place.

  7. Martin
    April 2, 2011

    The UK banks are a still a mess. I can’t help but think that if our banks were on the way to recovery the coalition would be keen to privatise them to help the government’s debts.

    What will happen if UK banks have to restate their mess to take into account a residential property slump? Who will bail the UK out?

    I would be careful about alienating those who might be able to help us in times of need.

    You are advocating a policy of
    “We will never need the fire brigade and so won’t be paying for it”.

  8. Mike Stallard
    April 2, 2011

    Here at a party in Saudi I had the privilege of listening to a government employee. to him it was simply common sense that, just as in USA where California has been in severe debt for years, so various staten in the European United States would also get into temporary difficulties.
    Whe I pointed out that even Angela Merkel has now lost Baden-Wurtemburg and that thigs were getting pretty seriously different to the USA, he just changed the subject.
    My question is this: how will Portugal leave the Euro? Will it mean ( a major bust up-ed) or some bad mouthing or just a quiet declaration? Maybe it will all be done so quietly that it won;t even reach the ears of the meeja.

  9. StrongholdBarricades
    April 2, 2011

    I would say our current banks don’t need anymore capital

    Just let some more players into the UK field and then turn off the “too big to fail” button

    If they come with the begging bowl again it is the shareholders and bond holders that take the hit, the bank is wiped out and capitalism prevails

    It is the duty of share holders to set the policies of their banks, not governments. Thus it is the share holders that bear the burden of loss, and consequently you might see the short term policies of the banks disappear with a much softer and longer outlook on the economy.

  10. Geoff not Hoon
    April 2, 2011

    Mr. Redwood, If the UK property scene unfolds to even 20% of the Spanish or Irish one for the banks then profit etc. will not matter a jot. I believe both residential and commercial property, in certain banks, is still being carried at way over reality and complicit auditors allow it to continue in the hope time will resolve the mess. Until a real audit is carried out on those banks involved the risk of failure remains IMHO and we the tax payer will be passed the hat again.

  11. Brian Tomkinson
    April 2, 2011

    JR: “Meanwhile it is important that the UK does not make any contribution to future Euro area bail outs.”

    Haven’t Cameron and Osborne already admitted that they are signed up to give away more money we don’t have to bail out the Euro?

  12. Derek Buxton
    April 2, 2011

    Those pesky regulators again, totally useless because the do not react speedily enough to any change. They interfere far too much, making decisions based on politics, not the market.

  13. Gary
    April 2, 2011

    The genie is out of the bottle. The collapsing biggest credit bubble in history will exact its toll. No matter the amount of fiddling on the periphery.

    “There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.“ Ludwig von Mises”

    We should plan what will happen after the dust settles and 100% reserve banking will go a long way to ensure such vast credit bubbles will not happen again. This govt shows no sign of understanding this.

  14. Frank Salmon
    April 2, 2011

    Spot on again John
    Can I suggest the real reason banks aren’t lending is because they are bracing themselves for another property collapse?
    They won’t lend if the value of collateral is expected to fall.
    My belief is that the real recession is just around the corner….

    However, you are right that in a recession, economic policies and banking practices compound the problem. The fact is that, sooner or later, we have to hit the bottom of the recession curve. Excessive government borrowing has compounded the problem, rather than making it better, and in the near future we will have to face up to reality.
    The following will go some small way to sort out the problems:

    Britain exits EU

    Germany exits Euro

    The public sector take a 20% wage cut

    The public sector take a 20% employment cut

    China allows the yuan to float

    World trade is liberated

    Monopolies – especially banks, are controlled or broken up where possible

    Governments stop pretending that they can create growth industries

    We stop all subsidies – rarely ever can they be justified

    We allow the private sector to provide, and profit from, provision of public sector services

    We seek to reduce the market for benefit dependency and encourage the growth of responsible family and parenthood

    We create the conditions for small businesses to thrive

    We reduce the culture of anti libertarianism – the rules, regulations and taxes

    We dramatically simplify the tax system

    We reverse the growing propensity to malicious litigation

  15. waramess
    April 2, 2011

    Regulation caused the problem in the forst place and regulation is what will cause future crisis. The people who cause the regulation are deemed to know what they are about but now it is quite plain to see that they don’t.

    They should try to remove regulation and start again. They will be tempted after a few collapses to bring in regulation again but it might just take another few hundred years for them to get into the same pickle.

    Ireland it should be remembered is a nation of just under four million people and every time another loan is made the powers that be should do a bit of quick short-division.

  16. cosmic
    April 2, 2011

    Whenever you hear talk of a “new paradigm” or “things being different this time”, you can be completely confident you are just about to see a very old phenomenon with a new suit of clothing – the bursting bubble.

    This is true of most major bubbles, people start to believe that it isn’t a bubble but some new principle has been found offering limitless wealth for nothing and which overthrows the previously held, and rather tedious, laws of economics, which are presumably, “the old paradigm”.

  17. Mark
    April 2, 2011

    In Ireland property prices have indeed crashed – by around 50%. Even if they fall a further 20% from here, that will be only another 10% of the value against which the loans were made, and any fall further than that is probably market overshoot to the downside which will not last. In Great Britain, property prices have not crashed, and indeed in some parts they have returned to bubble peak values. There is much pain still to be endured when the market is eventually allowed to restore sensible values. We still have £1,239bn in mortgages outstanding according to the BoE, crowding out other lending.

    Regulation by numbers has indeed failed. Classifying government debt as risk-free has proved to be as much folly as under-risking mortgages and their derivatives. However, the loans to governments and property buyers have been made. They are only being serviced in many cases because of subsidies to interest rates and bailouts to governments. The Irish are at least facing up to some of the consequences, even if those who lent to them have yet to do so.

    We should not fear corrections in asset prices because until they happen there will be no secure basis for lending. Indeed, the faster that asset prices can be corrected without generating a systemic banking crisis, the sooner we will return to a healthy economy. Propping up asset prices and failing to sort out bank balance sheets is a recipe for long term misery.

    When we have sorted that out we can think in terms of using judgement to assess banking risk, not rulebooks. It worked quite well after Bagehot wrote Lombard Street in the aftermath of the Overend, Gurney collapse until Brown set up his disastrous tripartite regime. Of course, we have to get the Euroregulator to recognise these simple facts too.

  18. david englehart
    April 2, 2011

    sadly it is necessary to finance the banks and encourage them to lend.
    only by growth in the private sector will we ever be able to get out of the mess we are in unless we become defaulters.
    this will need patience combined with a decrease in the public sector and its drain on the private sector who finance it.
    it will not happen overnight but i have little faith that the voters will understand this and i shudder at the prospect of another labour government in 2015 with a continuation of its destruction of the private sector in its headlong pursuit of bribing its public sector voters with money and jobs we cannot and never could afford.

  19. forthurst
    April 2, 2011

    I am all in favour of not using taxpayers money to bail out the Eurozone. I am all in favour of not dishing out taxpayers’ money to foreigners at all, whether there or here and especially if such largesse is DU-tipped.

    I may be mistaken but it might appear that JR is arguing for propping up the property market on the grounds that it is now ‘a lot lower’. I see no reason why banks should lend money for individual house purchase other than on the basis of a very conservative assessment of ability to pay. I see no reason why banks should be concerned to lend to property companies, large or small, risking another asset bubble, when businesses that can add value are suffering a funding drought. We need to get away from the concept of the property market as our motor for growth because it always overheats and breaks down. Unless we stop treating the health of our too-big-to-fail banks and an inflated property market as the main vital signs of our economy to be massaged with an absurdly low discount rate and fatuous schemes to ‘help’ first time buyers, we will never have a proper recovery.

    It is, however, hard to argue that banks should be contrained from lending to well run businesses here, in favour of holding loan stock issued by poorly run countries (gilt-edged? tungsten-filled, more likely).

  20. sm
    April 2, 2011

    Let interest rates rise slowly to a neutral level and find out? Otherwise all those on going subsidies need to be milked.

    I suspect we may need to recapitalise or create new bank/s unencumbered with prior debt. They should be directed to industrial-productive growth commerce areas not residential re-mortgages.

  21. James Sutherland
    April 2, 2011

    Whenever I read or think of our current banking regulatory system, I am reminded of a drunk driver. They can see which direction the road goes, but as the car drifts off course in one direction, they react too slowly, then oversteer, swerving in the opposite direction. Once they notice this, they oversteer back again. I would say right now our banking regulatory vehicle has clipped a passing truck, but now we’re bumping over the grass verge towards a ditch and the regulator is bragging about all the green shoots of recovery under the wheels now. The used car salesman in Kirkcaldy boasted of how the sloppy steering was a great new feature, making the wheel easier to turn, of course. I just hope we can drive back onto the road without hitting anything and without needing to phone for another IMF tow truck this time.

    Simply reducing the regulator’s official assessment of the safety of sovereign versus private debt should go a long way to fixing most of this problem – as, of course, would stemming the flood of supply of sovereign debt we have right now. Is it really that much safer to lend money to Portugal than to McDonalds or CocaCola? Probably not, but apparently the regulators believe otherwise.

  22. Euan
    April 2, 2011

    Banks have evolved into the perfect system for extracting money from every other sector of the economy. No area is safe- government, business or private individuals. Because of the stupidity and/or corruption of regulators and politicians hundreds of billions have been diverted into bank coffers through money creation, fees, interest and subsidy when it should really be in use to sustain the productive. We are all servants of the banks, destined to be in debt from birth until death.

  23. John Ward
    April 2, 2011

    ‘The regulators have regulated the commercial banks into too much sovereign debt risk at the wrong time, whilst discouraging private sector risk at a time when we need more loans to power recovery.’

    That is, if I may say so, a somewhat eccentric analysis of why Banks don’t lend to small business. If it be the case, why do the have so much to lend on M&A? How can they pay such huge bonuses?

    There is a tendency at the moment to talk of regulation as if it might be a contagious form of leprosy. Regulation is simpy a set of rules to restrain those who do not know how to behave.

    Bob Diamonf six weeks ago preened himself on the basis of having 12% liquidity. When Lehmen went under, it had 13.2% liquidity. Derivative multiple and bets on them that go wrong are why invetsment banks need upwards of 20% liquidity.

    Reply: Barclays is of course a global bank, not a specialist investment bank

    1. Lindsay McDougall
      April 6, 2011

      Barclays is a bank that did NOT, repeat NOT, hold out its begging bowl to the UK taxpayer. Instead, it borrowed from Arabs, whose only interest is to make a buck.

      Why don’t you all learn to DISCRIMINATE which, contrary to politically correct opinion, is a very good thing. Northern Rock, RBS and Lloyds (at least the HBOS part of it) are failed companies. Barclays is not. The size of bonus that Barclays pays its CEO is a matter for the Barclays remuneration committee and its shareholders and nobody else. The size of the bonuses received by the CEOs of Northern Rock, RBS and Lloyds IS a matter in which HM government can be involved because it is supposed to be looking after our interests.

  24. Susan
    April 3, 2011

    I have accepted, that Britain may lose a good portion of its lucrative financial sector. However, my original thought was when the Conservatives came to Government, they would stop “banker bashing”, but this has not been the case. I see no reason why Barclays would not relocate to New York who have said they will welcome them with open arms. HSBC may also consider a move.

    Banks need robust, unambigous regulation not more regulation. During the Labour years this was sadly lacking. Anyone with a modicum of sense could see there were problems on the horizon during the boom years, so why could the so called economic “genius” Brown not see it. The fact is he did, but the taxation from the financial sector was too much to resist for Brown. Warnings about the state of the banks was highlighted well before the financial crisis began and were ignored. So why are these people such as Brown not being held to account for bringing the financial system to its knees?

    Then came the run on Northern Rock. Again the Government response was wrong, allowing the run to continue whilst they dithered, instead of guaranteeing the publics deposits from the beginning of the crisis which would have stopped the run on NR. The bail outs, I believe, also should have been handled differently. Just throwing money at banks which contain toxic debt has never to my mind been a credible solution. A more painful, but more cost effective mechanism for the taxpayer way was available, which Brown and Darling did not take. Toxic debt will be exposed anyway when interest rates go up. Surely aggressively running off the debt, would have been unpopular but far more effective. Then came the disasterous Lloyds merger, which to my mind only came about to win a Scottish bi-election for Labour. The banks have been used very much by Labour as a political football, Vince Cable and George Osborne have perpetuated this stance since the Coalition came to power.

    Brown introduced banking bashing as a scapegoat for his mistakes. That is not to excuse the banks however. This perception was taken up by the public who are complicit in blaming the bankers, have much to answer for themselves. Many of the public took out loans they knew they could not afford, but the blame culture in Britain is very strong, and the banks fit this bill.

    So Britain is left with the situation that should banking regulation go too far without the rest of the World following, the UK will become uncompetitve in this area of finance as well.

    Having said all of this, do you believe there is a real demand for loans at this time? After all, are companies wanting to expand or are they consolidating instead. There will always be demand for poor loans and bad business model loans, but that would only bring the banks back to the same problems that caused the financial crisis in the first place.

  25. Richard
    April 4, 2011

    The Greek bailout was also illegal (as indeed was the EU section of the Irish bailout). Why did the UK government not take the EU to court to stop this?

  26. Dan H.
    April 4, 2011

    The basic problem here is a perception that some banks will cause so much trouble if they collapse that they are thus effectively “too big to be allowed to fail”. The solution here to a lot of problems is thus to ensure that no single banking entity ever becomes “too big to fail”. I propose a simple solution: banking supertax.

    Work out how large an institution must be for it to be “too big to be permitted to fail”, knock say 5% off this size for good measure, and apply an outrageously exhorbitant supertax on all organisations over this size limit. The tax thus imposed won’t ever collect a penny, nor is it intended to; it will force organisations that are getting too big to fission into smaller entities.

    Then all you have to do is guarantee the deposits of people who have banked with a bank, up to a certain limit, exactly as happens now. If in future a bank acts like Northern Rock and sets its self up for a fall, all you do is let it fail.

    Failure absolutely must be an option in a banking system. If failure is not possible (as it wasn’t when a major bank that lent to Labour supporters engineered its own financial suicide), then all you get is ever-more outrageous risk-taking because there simply isn’t a downside to such insanely silly banking. The banking sector will soon wise up and sober up if some major players are allowed to destroy themselves whilst the Government does the political equivalent of sit on the sidelines selling popcorn and laughing at the clowns.

  27. Lindsay McDougall
    April 4, 2011

    You are making this far more complicated than it needs to be. You just tell Stephen Hester that RBS must reurn to profitability within a year, otherwise he will lose his job as CEO of RBS. That will cause him to sell off RBS assets as necessary – he has plenty of those, especially as RBS policy is not to rebrand companies that it acquires. The government can also set a stiff profitabilty target for the CEO of Lloyds, with a similar requirement to sell off assets as necessary.

    The government should also encourage new players in the banking market to buy these assets. Such companies should be UK owned and the perks available to SMEs should be available to them for a limited period of a few years.

    Having put this in place, the government will then sell off its shares as opportunities present themselves in the markets. As the major shareholder in both RBS and Lloyds, HM government can insist on shareholder EGMs to report progress by those companies.

    There is no need for further taxpayer support. There is a need to say and mean that no bank is too big to fail and that the normal rules of capitalism apply. Banks are NOT special. Regulation should be restricted to saying that bank capital ratios should exceed a (fairly low) threshold.

    To complete the picture, the Bank of England should set base rate at a believable level of around 3%.

    Government is the problem, not the solution. You can even blame governments and monetary policy for the property price boom and bust that led to this situation in the first place.

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