Hamish McRae: We keep getting the balance so wrong when it comes to banking

The big point here is we have to patch... there is no point in endlessly playing the blame game

If you tell banks they must be safer, don't be surprised if they cut back their riskier forms of lending. This inconsistency in public policy has just been highlighted by an outburst by Vince Cable, attacking the Bank of England for being "capital Taliban" in imposing higher capital requirements on banks, requirements that impair their capacity to lend to business.

I have some sympathy for his view because, as you can see in the top graph, the flow of funds to the UK private sector is abysmal. Indeed there is no net lending at all, and while the 12 per cent annual increase in lending at the height of the boom was bound to end in tears, having banks that won't lend anything does explain the sluggish nature of the recovery. But while there can be genuine concerns about the speed at which the Bank is requiring the banks to increase their capital ratios, the harsh truth is that having adequate capital is the core strength of any bank. It is the first line of defence when loans turn sour and if you want a system that will never have to be propped up by governments again, one of the two things they have to have is a solid capital base. The other? Cautious lending policies.

There is a genuine, and actually very interesting, debate about the balance between capital and caution. Some people argue that having a lot of capital is a less effective path to safety than lending only to people who are likely to pay back. Others prefer to stress capital adequacy. Of course, you have to have both and, of course, the key is pricing risk. There is nothing wrong with risky lending, for example for consumer purchases, provided you charge enough for the loan to cover the inevitable losses. You can see the write-off rates for different categories of lending in the other graph. Lending on property in the UK is inherently safe, whereas lending to consumers isn't. That is why we pay such high rates on credit cards. Lending to small business is somewhere in between, but note that while write-off rates on consumer lending have fallen back, those on business loans have not. Lending to a small business would now seem to be almost as risky as it was in the early 1990s slump, and more risky than at any time since the mid-1990s.

No wonder banks are cautious. It is an inevitable and understandable response to their over-exuberance five and more years ago and nothing Mr Cable says will change that. Indeed by attacking, as he put it some time back, "casino banking", he probably contributed to their present attitude. He intended by that remark to refer to investment rather than commercial banking, but their greatest losses have not in general been in investment banking but rather in commercial lending. The casino was, so to speak, a property development in the middle of Ireland.

This is not the only inconsistency in public policy towards the banks. The Government, reasonably enough, wants the best price for taxpayers' investments in the banks it rescued. Lloyds' share price is now higher than the price of the Government's investment, so we are in the money. Lloyds, incidentally, is now the second most valuable bank in Europe, having just nudged ahead of Santander. This is a tribute to its chief executive, Antonio Horta-Osorio, who was previously head of Santander's UK business. When the first tranche of our shareholding is sold, probably this financial year, he will have earned his bonus.

But the share price of Royal Bank of Scotland languishes. Why? Well it is partly that there was more rubbish to clear out, but also RBS has been subject to attacks by the Government and the Bank of England. Some of it was private over the lunch table: "Of course, they can cut back, but they have no vision for the future – that is why we will have to get rid of Hester," I was told by someone very senior in the world of officialdom.

The public attacks are something else. Thus Sir Mervyn King, when still Governor, called for RBS to be split into a "good bank" and a "bad bank". That was picked up by the Chancellor, and the Treasury is examining that. We will learn in September what they plan to do. Splitting off the duff loans from the ongoing banking business is a standard practice and can work perfectly well. But while there is a reasonable argument that RBS should have been split back in 2008, to bring it up now when it is three-quarters of the way through sorting itself out is nuts.

It is worse than that – it is destructive of the value of the bank. If you think there is a case for cleaning up things before the sale, you look at that quietly in private; you don't undermine management and staff with a half-thought-through proposal.

The big point here is that we have to patch the existing system rather than build one from new. It is unfortunate it is so damaged, though not as gravely as much of European banking, but there is no point in endlessly playing the blame game. If people have broken the law, that is one thing; if they have merely been stupid, that is another. There is always a choice between having a banking system that prioritises the safety of depositors and one that takes risks lending to businesses that may not be able to repay. We got the balance wrong one way and now we are probably getting the balance wrong the other. But we are inching in the right direction, and the sale of the first bit of Lloyds will be a signal of that.

Suggested Topics
Start your day with The Independent, sign up for daily news emails
Life and Style
love + sex A new study has revealed the average size - but does that leave men outside the 'normal' range being thought of as 'abnormal'?
The Palace of Westminster is falling down, according to John Bercow
voices..says Matthew Norman
Steve Bruce and Gus Poyet clash
Arts and Entertainment
Jake and Dinos Chapman were motivated by revenge to make 'Bring me the Head of Franco Toselli! '
arts + ents Shapero Modern Gallery to show explicit Chapman Brothers film
Arts and Entertainment
Kurt Cobain performing for 'MTV Unplugged' in New York, shortly before his death
music Brett Morgen's 'Cobain: Montage of Heck' debunks many of the myths surrounding the enigmatic singer
Brendan Rodgers
football The Liverpool manager will be the first option after Pep Guardiola
Life and Style
ebooksA special investigation by Andy McSmith
Christian Benteke of Aston Villa celebrates scoring the winner for Aston Villa
Arts and Entertainment
Myanna Buring, Julian Rhind-Tutt and Russell Tovey in 'Banished'
TV Jimmy McGovern tackles 18th-century crime and punishment
Arts and Entertainment
Paul Whitehouse as Herbert
arts + ents
Bill O'Reilly attends The Hollywood Reporter 35 Most Powerful People In Media Celebration at The Four Seasons Restaurant on April 16, 2014 in New York City
media It is the second time he and the channel have clarified statements
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Executive - OTE £40,000

£15000 - £18000 per annum: Recruitment Genius: This is a great opportunity for...

Austen Lloyd: Law Costs HOD - Southampton

£50000 - £60000 per annum + Excellent Salary: Austen Lloyd: An outstanding new...

SThree: Recruitment Resourcer

£20000 - £21000 per annum + uncapped commission: SThree: As a graduate you are...

Ashdown Group: Junior Application Support Analyst - Fluent German Speaker

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Day In a Page

Syrian conflict is the world's first 'climate change war', say scientists, but it won't be the last one

Climate change key in Syrian conflict

And it will trigger more war in future
How I outwitted the Gestapo

How I outwitted the Gestapo

My life as a Jew in wartime Berlin
The nation's favourite animal revealed

The nation's favourite animal revealed

Women like cuddly creatures whilst men like creepy-crawlies
Is this the way to get young people to vote?

Getting young people to vote

From #VOTESELFISH to Bite the Ballot
Poldark star Heida Reed: 'I don't think a single bodice gets ripped'

Poldark star Heida Reed

'I don't think a single bodice gets ripped'
The difference between America and Israel? There isn’t one

The difference between America and Israel? There isn’t one

Netanyahu knows he can get away with anything in America, says Robert Fisk
Families clubbing together to build their own affordable accommodation

Do It Yourself approach to securing a new house

Community land trusts marking a new trend for taking the initiative away from developers
Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

Money, corruption and drugs

The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

150 years after it was outlawed...

... America's first slavery museum is established in Louisiana
Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
Tony Oursler on exploring our uneasy relationship with technology with his new show

You won't believe your eyes

Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

Moores must go. He should never have been brought back to fail again

The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn