David Prosser: Governor's call for banks to raise capital ratios can only be bad news for businesses

Outlook Having spent Tuesday promoting an Autumn Statement full of schemes to promote lending to small and medium-sized businesses, George Osborne can't have been too pleased to read yesterday's Financial Stability Report from the Bank of England. It was full of reasons for the banks to lend less rather than more.

OK, that's not what Sir Mervyn King, the Bank's Governor, actually said. Quite the opposite, in fact – he explained that while banks did need to build up capital in the face of the eurozone crisis, they should do so by showing restraint on bonuses and dividends, rather than reducing lending.

To which one can only say, best of luck with that. For Sir Mervyn knows better than most that this is not how the City operates.

Banks facing calls to raise their capital ratios can respond by topping up their reserves – in the way Sir Mervyn suggests, for example – or by shrinking the balance sheet, which sits on the other side of the equation. The latter is the easier option.

The Bank is doing its best to stop Britain's financial sector being dragged into a second credit crunch – making it clear yesterday, for example, that it is happy to see liquidity buffers run down at banks struggling with blocked-up wholesale funding markets. That will be helpful in the short term, but in the end the eurozone crisis is about solvency rather than liquidity – Sir Mervyn's desire to see capital reserves increased reflects his concern about banks' exposure to insolvent sovereigns across the channel.

The total compensation banks award their staff will be down on previous years – not because of the Bank's pleas, or even a desire to placate the City's critics, but because 2011 has been a miserable year for investment banking. Do not expect the banks' rainmakers to be any less demanding though, or for shareholders to compromise on dividend payments.

Where does that leave businesses and households who want to borrow? The short answer is not in a place that is any happier than today. That is to say credit will remain constrained – and many borrowers may find that even the loans they are offered come at too high a price.

Meanwhile, we wait with interest for further details of the counter-cyclical tools the Bank of England will soon have at its disposal in order to promote financial stability. One of those tools is expected to be the option of reducing capital requirements in order to promote credit provision at times of stress. The problem is that when the stress is caused by the potential for a banking crisis, that's not a tool the Bank can afford to use.

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