David Prosser: This bailout won't get the banks lending

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The Independent Online

Outlook No one is going to buy the idea that £40bn is anything other than a huge sum of money. Still, the latest taxpayer investment in Lloyds and Royal Bank of Scotland – up to £39.2bn to be precise – is likely to be dwarfed by a much larger figure tomorrow. The Bank of England is widely expected to announce an expansion of its quantitative easing programme, with the betting currently on a £50bn increase to £225bn.

The whole point of QE, of course, was to get money flowing through Britain's recession-hit economy. The transmission mechanism through which the Bank was once able to improve the supply of affordable credit, cuts in interest rates, stopped working, and QE was the answer.

That such a massive expansion of the programme is now on the cards suggests that QE has not yet worked, or at least not on the scale that the Bank was hoping for. But you don't need me to tell you that: businesses up and down the country continue to complain about the difficulty of obtaining credit on reasonable terms. Nor has the mortgage market returned to normality. Even on the Bank's own preferred yardstick, money supply growth, progress has been slow.

It wouldn't be unreasonable to expect, then, that in return for the latest £40bn taxpayers are throwing the way of the banks, they might promise to switch on the credit taps. Such a pledge, however, was not forthcoming. Neither Lloyds or RBS made a single new commitment to lend more yesterday.

How could they? The money these banks are raising is not for normal trading purposes but to shore up their balance sheets, through a combination of additional capital and insurance against potential future losses on toxic assets.

In fairness, both Lloyds and RBS may have been the architects of their own demise, but since the crisis they have been given two irreconcilable instructions: to improve their capital strength while simultaneously lending more to both businesses and individuals.

The good news is that with these fundraisings, the first of these orders has finally been obeyed. Once the cheques of shareholders and the taxpayer have been banked, both RBS and Lloyds can finally move past the balance-sheet worries. Less happily, however, this does not mean that either bank is now in a position to begin lending more. Their current trading prospects will not allow it.

RBS is in a particular bind. It lost more money than any British company in history during 2008, and was again loss-making during the first half of 2009. Its prospects of returning to the black will not be helped by the European Commission's order that it must sell some of its most profitable assets. The restrictions on bonuses may hinder the performance of many of the remaining businesses. Not much scope for a significant expansion of lending there then.

Lloyds is not in quite such a deep hole. Indeed, by recent standards, its trading update yesterday was relatively jaunty. On impairments, the second half of 2009 will be better that the first half, and 2010 as a whole should be better than this year. Note, however, that sizeable impairments are still to come, most of them originating with the HBOS loan book. And the bank still expects to report a loss for 2009 as a whole.

It's worth pointing out, moreover, that the banks are expecting the UK economy to improve over the next 12 months. A double-dip recession (assuming we ever make it out of the first part of the downturn) would put both RBS and Lloyds even further behind on their recovery plans.

Does all this imply that the taxpayer is throwing good money after bad with this latest bailout? Well, it's still not impossible that both banks might have to be fully nationalised – there are certainly City banking analysts who advise selling both group's shares precisely because of this risk. But in truth, it's difficult to see what option Alistair Darling had other than to support yesterday's cash calls. Both banks had to take the routes they eventually chose in order to have any hope of a viable future, and as the largest shareholder in Lloyds and RBS, the taxpayer was always going to participate once the right path was picked.

Back to the Bank of England, then. For the sake of all taxpayers, we must now hope that the next £50bn of QE cash succeeds where the first £175bn failed. If the banks can't get more money flowing through the economy, the Bank must step in.

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