Anthony Hilton: Can the banks have their cake and lend it out too? Something's got to give

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The Independent Online

I have no problem with the Bank of England being in charge of monetary policy and having the responsibility to help deliver stable prices and economic growth. Separately I have no problem with the Bank of England having overall responsibility for the stability of the financial system. The problem is whether it is possible for the Bank to do both at the same time.

There is nothing new in this observation – it was at the core of objections to George Osborne's knee-jerk decision when he came to office to break up the Financial Services Authority and return responsibility for banking supervision to the Bank – a decision which comes into effect this weekend. But developments this week put it into sharp focus.

For some months now we have seen the Monetary Policy Committee of the Bank come up with various devices to encourage the banks to lend more to business. The biggest and most ambitious of these is the Funding for Lending scheme, which in effect subsidises the banks if they make new loans, on top of what they have on their books already. In theory it should make it easier for them to lend more and help to get the economy moving.

But on Wednesday the Financial Policy Committee, the bit of the Bank charged with financial stability, published a report on the health of British banks – prepared for it, as one of its last acts, by the Financial Services Authority. The raw conclusion was that British banks and building societies need an extra £50bn of capital to cope with possible future losses on commercial property and the eurozone, payments in compensation for past misdeeds, and being more prudent in their calculations of risk.

As a result the committee thinks the banks should raise at least £25bn of new capital by the end of this year, and has told another Bank committee, the Prudential Regulation Authority, to make sure it happens. The PRA should then chase the banks to make sure they carry on raising capital.

So on the one hand the Bank is pushing the banks hard to lend more; on the other it is demanding they raise huge amounts of capital, which in effect means that money they might have lent out will instead get diverted to reserves. The timescale must surely mean it is highly unlikely that they will be able to lend more.

The Policy Exchange think-tank helpfully pointed out that bank lending to private companies in the UK has fallen by £10bn a year every year since the start of the financial crisis. "Increasing the capital ratios even further, as the FPC is proposing, will lead to a further lack of credit," it says. "It is the Bank's drive to raise capital ratios that is holding back lending."

The relationship might not as clear cut as this comment suggests. But you do have to wonder whether the best way to get maximum performance from a car is by pressing both the accelerator and the brake at the same time.