Between the peak of the credit boom and the end of the first quarter this year the balance sheet of RBS contracted from £2.2 trillion to £1.4 trillion. In other words, the bank felt the need to cut its assets and liabilities, its financing of the UK and world markets, by a massive £800 billion.
Let’s allow for the fact that a lot of this was global, not UK. Let’s allow for the fact that a lot of it was cutting positions in derivatives and futures. Nonetheless, it was a huge reduction in liquidity and credit for world markets. What the Bank was doing just in the UK market was bound to have an impact on growth and activity.
What RBS was doing on a huge scale other banks were doing to a lesser extent. The banking regulators lurched from being too easy, allowing a credit binge, to being too tough. Their new belief in better cash and capital ratios meant that all banks decided to cut their loan books and take other action to improve their balance sheet ratios.
The government became aware that smaller and medium sized enterprises were finding it difficult to get bank finance. Large companies regained access to the corporate bond market and the equity market on acceptable terms, options not open to the broad mass of UK companies. So Ministers invented Project Merlin. The banks have promised to do better and lend more to UK companies.
Let’s hope they do, and let’s hope such loans are well based and successful. It would be easier if the banks at the same time were told they now have enough cash and capital, so they do not have to keep squeezing the loan book down to improve the ratios. Ratios are much healthier than in 2007-8. The time for the Regulators to demand more cash and capital is once growth has picked up and credit is flowing freely. It is not a good idea to demand more when the economy is growing slowly and credit is still scarce.
Many now say they believe in counter cyclical regulation, but there is no evidence of it happening. Regulators fuelled the boom, and helped create the bust by lurching from too easy to too tough. The UK economy needs a bit more help at the moment from credit, not a further hair shirt.
We also need more competition n the banking market. We need more banks on the High Street, with some banks pioneering a newmodel – or recreating an older model- of local relationship banking to banks the smaller businesses sensibly. That can be done through the Vickers Report remodelling. I would also link it with returning the state owned banks to the private sector as soon as possible.