Sunday, December 19, 2010
Break-up fears could hit lending
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular piece is available to subscribers on - this is an excerpt.

There are three worries about the 2011 outlook. One is that external events will derail recovery, of which the most obvious candidate remains the eurozone.

The European Central Bank last week virtually doubled its capital base, taking out crisis insurance. The second worry relates to “the cuts” and the tax increase. More on that and global risks, over the next 2-3 weeks.

The third worry is the banking system’s ability to support the economy. Last week the Council of Mortgage Lenders confirmed what its members have privately told me; anybody looking for a big upturn in mortgage lending will be disappointed.

Gross mortgage lending will be similar to this year’s £135 billion and net lending will drop from £9 billion to a three-decade low of £6 billion. Housing activity will trundle along at half of pre-crisis levels.

What about the more important business lending, currently showing an annual fall of over 5%? The Bank of England’s latest quarterly bulletin found “a substantial and persistent tightening in credit supply conditions” alongside the drop in credit demand that is normal in recessions.

The banks, for their part, insist their business customers have unused credit facilities that will come through as the upturn gathers pace. Peter Ibbetsen, RBS’s head of small business lending, says there will be two spikes in credit demand from smaller firms over the next 12-18 months.

One will be when their cashflow needs increase as activity returns towards normal levels, employees are taken off short-time working and stocks are replenished. The other will be when firms need to borrow to invest in new capacity.

Ibbetsen is confident that, just as RBS will meet its £50 billion commitment to lend to small and medium-sized businesses by the end of March, so will the banks as a whole. Lending to businesses, currently down on an annual basis, will return to growth over the next 12-18 months. We should hold the banks to that.

In the meantime, the government is giving a fair wind to new ways of funding small and start-up businesses. Earlier this month Paul Forrest of Forrest Research gave a presentation to the Accumulation Society, a City-based club for economists. He described the workings of the Black Country Reinvestment Society, a mutual organisation which provides finance to small firms which have no track record or fail conventional credit scoring tests.

Forrest argued that the banks have never really lent properly to this type of business. As long ago as the 1930s the Macmillan committee identified this as a gap in Britain’s financial system.

Last week Mark Prisk, business minister, endorsed this “micro finance” lending to firms, offering improved access under the enterprise guarantee scheme. It will never replace bank lending but is a step towards the kind of diversity in business funding available in Germany.

Could longer-term banking issues impact on shorter-term lending? One worry about the banks, rehearsed in the Bank’s Financial Stability Report on Friday, is the £400-500 billion of maturing bank debt, including support under the special liquidity and credit guarantee schemes, that has to be rolled over by the end of 2012.

The Bank thinks the banks have made good progress in improving resilience and managing their funding, but it is a hurdle.

Another is the threat of government-imposed changes to the banking system. Will banks lend to support the recovery if they fear they are about the be broken up? Could that threat of act as a blight over banking?

I have mixed feelings about this. If you wait until a crisis is forgotten before taking action, the steam will have gone out of it. If you act too soon, you threaten damaging recovery. History tells us America acted quickly with the 1933 Banking Act (the Glass-Steagall Act), which shook up the banks, separating commercial and investment banking. But the depression lasted.

Britain’s independent commission on banking, chaired by Sir John Vickers, has pledged it will pay “careful attention” to the cost and availability of credit and the implications for growth.

The commission’s brief is wide, ranging from whether the banks should be broken up on competition grounds, to whether commercial and investment banking should be divided, Glass-Steagall style. Some commissioners favour very narrow banking, others argue that if governments pick up the tab when banks fail, you might as well have fully nationalised banks all the time. The case will be put for an increase in bank capital beyond anything proposed under the Basel III framework from the Bank for International Settlements.

The commission will not report for another nine months. It will be a fascinating intellectual exercise. Even so, apart from the limits on Britain’s freedom on banking reform - the European commission has greater powers in this area - reform of any sector by government diktat creates a sense of unease.

If governments are unhappy about how part of the economy is working, they can make it easier for other firms to enter the market, or act on monopoly or collusive behaviour. What they do not normally do, these days at least, is force break-ups.

You could argue that the banks behaved so badly that they surrendered their entitlement to normal treatment. You could argue, equally, that the banks would not have behaved so badly had they been properly regulated, and not just in Britain.

Either way, the worst thing would be if the banks did not lend to firms in a way that supports recovery. Even worse would be if the threat of break-up provided the excuse for inaction.