Hamish McRae: Pressure on banks to hold capital will damage lending
Our financial masters seem determined to make investing in banks as unattractive as they possibly can
Thursday 28 March 2013
Let's start with a simple question. If British banks are required to hold more capital to support their present level of lending, are they likely to increase or decrease their loan book? The answer is obvious enough. They are not likely to increase their loans and there will be pressure on them to reduce lending. Ah, but they will not be allowed by the authorities to cut their lending, so they will have to meet these new requirements by raising more capital.
So what is the proposition that they will make to potential subscribers to new equity? We are being told to raise this additional capital because we are deemed to be too risky as we are without it? That does not sound a wildly attractive investment opportunity, particularly as shareholders in the two Scottish banks have been pretty much wiped out.
If you slag off the banks, as our society has for the past five years, it becomes harder to persuade people to invest in them. If you say they should pay lower dividends to recoup the cash for this new capital that makes it even harder. And if you have an additional levy, over and above corporation tax, on whatever profits they might make, it makes it harder still. Oh, and by the way, the majority shareholder in Royal Bank of Scotland and the large minority shareholder in Lloyds Bank are not going to put up any more capital.
Investors are not totally stupid. At a price they may well be prepared to make more capital available to the banks. But the terms under which the proposition is framed have to be attractive, or rather more attractive than the alternative investment opportunities. At the moment our financial masters seem determined to make the idea of investing in banks as unattractive as they possibly can.
To say all this is not to quarrel with the aim of the regulators, which is to have a safer banking system. Requiring banks to have a larger capital cushion against duff loans is one way of making them safer and it seems that the additional £25bn of capital our banks require is rather less than the market expected. So as a medium-term objective it is fine – though there is an argument that there are other ways of ensuring safer banks without this preoccupation with capital. My point is that this initiative is not cost-free. At the margin it will make it harder and/or more expensive for British companies to borrow money.
This is implicitly accepted in the regulations as they apply to new banks, for to encourage their growth they are not being required to hold as much capital as established ones. But rationally what is more risky, a brand new enterprise founded by some enthusiastic entrepreneur, or an established bank, battle-scarred from the worst crisis in living memory? Yet the risky new ones are to have less capital than the old seasoned ones. Huh?
What the authorities are trying to do is to get more competition into banking and that is admirable. Before the crash there was arguably too much competition, which drove down lending standards. But you can see the collapse of lending that took place in the top graph and something has to be done about it. That snapshot was taken just after the introduction of the funding for lending scheme was starting to take effect and we will get a proper update on lending from the Bank of England next month. What we need is a happy medium. Back in the period 2004-2008 bank lending was rising by 10-12 per cent a year. That was nuts. With an economy growing at, say, 3 per cent and inflation around 2 per cent, you would expect bank lending to increase by 5-6 per cent.
Some of us were very worried about it at the time but the regulators did not seem to mind.
I do think, by the way, when the economic history of the period is written in another 10 or 20 years' time, the banking and monetary authorities will be regarded much more harshly than they are today.
But where we are now is that we need more bank lending. We don't want another banking boom but we have to get those two lines (slightly different measures of the same problem) up above the waterline again. Getting the banks to raise more capital just to underpin their present level of lending does not help at all. Indeed it may make it harder for other businesses to raise equity. There is a limited pool of funds and one of the problems at the moment is that from a company point of view raising new equity is not a particularly attractive way of getting capital. You can see that in the bottom graph, taken from a Deloitte survey of finance directors. As you can see, from their perspective by far the best way to raise money is to issue a bond, understandably so as such long-term yields are at historic lows. The next best is to go to the bank, if you can. And the least attractive is to issue new equity. That is a long-term problem that needs to be tackled because if companies are to take risks they need risk capital. So if the banks were to go into the market they will, at the margin, push out other would-be issuers by pushing up the costs.
Moral? There is a medium-term case for increasing bank capital. But the short-term need to get more money to the banks' customers is surely a greater priority and I suspect in five years' time we will realise we got our priorities wrong.
Growth figures are not as bleak as they may seem
The upward revisions in GDP continue to come through. There was no revision yet to the first-quarter figures, which remain negative, but in the small print of the latest report from the ONS is the fact that growth last year has been uprated to 0.3 per cent. That is not great, but the overall figure has been depressed by the fall in output from the North Sea. Final domestic demand grew by 1.3 per cent, with households benefiting from the rise in employment. Investec, the fund manager, notes that the savings ratio is now 7.1 per cent, the highest since 1997. The real worry, actually, is the current account, for exports are particularly poor. That is what we should focus on, not the double dip that wasn't.
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