Ben Chu: The banks will take a hit – but their pain is the economy's gain

The benefits to the British economy of a safer banking system are huge

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The Independent Online

The banks have warned that the reforms recommended by the Vickers report will jeopardise economic growth in Britain. The Ernst and Young Item Club released a report last week claiming that the proposed changes will increase the cost of borrowing for big companies by up to 1.5 percentage points and reduce national economic output by up to 0.3 per cent.

Does this argument have any merit? As the Vickers report points out, we must distinguish between the costs to banks and the costs to the wider economy. The capital markets believe that banks seen as "too big to fail" have a de facto government guarantee, and so charge them a lower interest rate for their borrowing than they otherwise would: lending to a large bank is considered entirely safe.

The reforms will remove the hidden subsidy enjoyed by such banks: only ring-fenced retail banks can expect to be rescued if a meltdown occurs. This means that the banks' overall funding costs will go up.

The Vickers Commission estimates the reforms will cost the banks between £4bn and £7bn a year. But, as Vickers notes: "It does not necessarily follow that there would be an equivalent – or indeed any – cost to the economy as a whole."

As the Business Secretary, Vince Cable has pointed out, for the banks to imply that they would recoup these costs by raising their charges for ordinary businesses and individuals is "blackmail". The banks could, instead, absorb these new costs by paying their employees and shareholders less.

The benefits to the British economy of a safer banking system are huge. Britain's banks received about £850bn in official support during the 2008 crash. But as Adair Turner, the head of the Financial Services Authority, has pointed out, the direct support costs were swamped by the "macroeconomic harm" inflicted on Britain as a whole. Since the meltdown, the ratio of UK public debt to GDP has jumped by at least 50 per cent. The Vickers report is confident that the national economic benefits of reform will exceed the costs "by a very large margin".

The banks tend to equate their own welfare with the general welfare of the economy. For a long time they persuaded ministers to take the same view. The Coalition's acceptance of Vickers' argument indicates that this spell may have been finally broken.

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