I’m going to write today about your guardian angel. The chances are you’ve never heard of him but he’s worked courageously these past two years to protect your living standards and quite possibly even your job. His name is Robert Jenkins and he’s been an external member of the Bank of England’s banking watchdog, the Financial Policy Committee (FPC).
Since July 2011 Mr Jenkins has made it his purpose in life to get our largest banks to build up their safety buffers, also known as their capital. Recall that the last time our big lenders slashed those buffers to thin cushions they crashed the entire economy and required a £1 trillion public bailout to prevent even worse damage occurring. We’re all still suffering from the effects of that meltdown, as the longest squeeze on living standards since the 1920s stretches on.
There is a reminder of what went wrong in 2008 in the Banking Commission’s latest report, which focuses on the failure of HBOS. It is a tale of a once prudent bank destroyed by reckless and greedy individuals, whose behaviour was abetted by incompetent and spineless regulators.
The trouble is that we seem to be fighting a national surge of amnesia brought on by people who seem to want us to forget that gruesome history. A host of commentators over the past week have suggested that the FPC’s recent instruction to our largest banks to increase their capital buffers by £25bn by the end of the year will mean that they can’t lend as much as they otherwise would to businesses. This is presented as a grotesque blunder by regulators that will harm the real economy and retard the recovery. “Every pound of extra capital the banks are told to raise is a pound less to be lent to small firms,” said one business editor of a national newspaper in a depressingly typical response.
There are two explanations for such statements. The more charitable one is that they are based on a profound ignorance of the mechanics of banking by people who have been brainwashed into seeing the world through the eyes of the banking industry. The less charitable one is that they are prompted by an intention to mislead.
Let’s go back to first principles. There are two sides to a bank’s balance sheet. On one side are their assets, the loans and investments the banks make. On the other side are their liabilities, the money they borrow to fund the bank’s loans and investments. And also their equity capital buffer.
It is important to note that while it is in the interests of taxpayers for banks to have big capital buffers, it is in the interests of bank managers to run their businesses on as low a level of equity capital as possible. This is because their bonuses are linked to their institutions’ “return on equity”. For a given level of profit, the smaller the equity, the bigger the return on that equity. And hence the larger the bonus.
Those who complain about instructions for banks to raise more capital imply that equity capital is a pot of money that sits idle on its balance sheet, when that money could otherwise be used for to finance new loans. The briefest consideration of the balance sheet described above shows that this is nonsense. Capital exists on the liability side of a bank’s balance sheet, not the assets side. It doesn’t crowd out lending.
The only way the FPC’s injunction could result in banks reducing their loans to the real economy is if their management attempted to keep their levels of capital constant and instead to increase their capital ratio by shrinking the asset side of their balance sheet. But this is something that the banks have been explicitly instructed not to do by the FPC. So those people who are citing this as a danger are effectively arguing that the banks will disobey their own regulator and hurt the economy to protect their own pay packets. If these people truly believe this is the likely outcome, it is curious that they regard the regulator, rather than the banks, as the appropriate target of their vituperation.
Now consider the wider economic benefits of higher capital levels beyond conferring upon our banks a more significant safety buffer. The reality is that far from undermining bank lending to the real economy, more capital will support it. The banks that have experienced the sharpest rise in their own borrowing costs since the 2008 financial crisis are those with the most meagre levels of capital. Similarly, the banks that have the worst records of lending to businesses since 2008 are those with the thinnest capital levels. This is no mystery. Investors regard under-capitalised banks as more likely to stumble and make losses. Banks with more capital are more likely to thrive. All the evidence suggests that if the banks raised bigger capital buffers they would see their borrowing costs fall and they would then be able to lend more to hard-pressed small firms.
Which brings us back to Robert Jenkins. No one on the Financial Policy Committee has been better at explaining the mechanics of the banking balance sheet to a lay audience. No one has been more insistent on the necessity of going beyond the minimum international capital standards set by the Basel committee for the sake of protecting British taxpayers. No one, save perhaps the outgoing Governor, Sir Mervyn King, has generated more hostility from the banking lobby for pointing out the simple truth of how our economy is being held hostage by the greed of a small number of reckless bankers.
But this tale does not have a happy ending, I’m afraid. Robert Jenkins, your guardian angel, was removed from the Financial Policy Committee by the Chancellor of the Exchequer, George Osborne, last week. I have learnt that Mr Jenkins applied to serve another term on the FPC but was rejected by a Treasury which was, apparently, keen to minimise the chances of the committee imposing any more troublesome capital demands on our big banks.
Our Chancellor decided that the banking lobby knew better than Mr Jenkins about how to safeguard taxpayers and how to promote lending. Draw your own conclusions about whether your living standards are any safer as a result. I know I, for one, won’t be sleeping any sounder.