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
Arts and Entertainment
Sir Bruce Forsyth with Tess Daly in the BBC's Strictly Come Dancing Christmas Special
tvLouis Smith wins with 'Jingle Bells' quickstep on Strictly Come Dancing's Christmas Special
News
peopleIt seems you can't silence Katie Hopkins, even on Christmas Day...
Arts and Entertainment
Wolf (Nathan McMullen), Ian (Dan Starky), The Doctor (Peter Capaldi), Clara (Jenna Coleman), Santa Claus (Nick Frost) in the Doctor Who Christmas Special (BBC/Photographer: David Venni)
tvOur review of the Doctor Who Christmas Special
Arts and Entertainment
Left to right: Stanley Tucci, Sophie Grabol and Christopher Eccleston in ‘Fortitude’
tvSo Sky Atlantic arrived in Iceland to film their new and supposedly snow-bound series 'Fortitude'...
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

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

iJobs Job Widget
iJobs Money & Business

Selby Jennings: Oil Operations

Highly Competitive: Selby Jennings: Our client, a leading European Oil trading...

The Jenrick Group: Night Shift Operations Manager

£43500 per annum + pension + holidays: The Jenrick Group: Night Shift Operatio...

SThree: Trainee Recruitment Consultant - LONDON

£20000 - £25000 per annum + OTE £40,000 + Car + Pension: SThree: SThree are a ...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £35K: SThree: We consistently strive to be the...

Day In a Page

Isis in Iraq: Yazidi girls killing themselves to escape rape and imprisonment by militants

'Jilan killed herself in the bathroom. She cut her wrists and hanged herself'

Yazidi girls killing themselves to escape rape and imprisonment
Ed Balls interview: 'If I think about the deficit when I'm playing the piano, it all goes wrong'

Ed Balls interview

'If I think about the deficit when I'm playing the piano, it all goes wrong'
He's behind you, dude!

US stars in UK panto

From David Hasselhoff to Jerry Hall
Grace Dent's Christmas Quiz: What are you – a festive curmudgeon or top of the tree?

Grace Dent's Christmas Quiz

What are you – a festive curmudgeon or top of the tree?
Nasa planning to build cloud cities in airships above Venus

Nasa planning to build cloud cities in airships above Venus

Planet’s surface is inhospitable to humans but 30 miles above it is almost perfect
Surrounded by high-rise flats is a little house filled with Lebanon’s history - clocks, rifles, frogmen’s uniforms and colonial helmets

Clocks, rifles, swords, frogmen’s uniforms

Surrounded by high-rise flats is a little house filled with Lebanon’s history
Return to Gaza: Four months on, the wounds left by Israel's bombardment have not yet healed

Four months after the bombardment, Gaza’s wounds are yet to heal

Kim Sengupta is reunited with a man whose plight mirrors the suffering of the Palestinian people
Gastric surgery: Is it really the answer to the UK's obesity epidemic?

Is gastric surgery really the answer to the UK's obesity epidemic?

Critics argue that it’s crazy to operate on healthy people just to stop them eating
Homeless Veterans appeal: Christmas charity auction Part 2 - now LIVE

Homeless Veterans appeal: Christmas charity auction

Bid on original art, or trips of a lifetime to Africa or the 'Corrie' set, and help Homeless Veterans
Pantomime rings the changes to welcome autistic theatre-goers

Autism-friendly theatre

Pantomime leads the pack in quest to welcome all
The week Hollywood got scared and had to grow up a bit

The week Hollywood got scared and had to grow up a bit

Sony suffered a chorus of disapproval after it withdrew 'The Interview', but it's not too late for it to take a stand, says Joan Smith
From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?

Panto dames: before and after

From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?
Thirties murder mystery novel is surprise runaway Christmas hit

Thirties murder mystery novel is surprise runaway Christmas hit

Booksellers say readers are turning away from dark modern thrillers and back to the golden age of crime writing
Anne-Marie Huby: 'Charities deserve the best,' says founder of JustGiving

Anne-Marie Huby: 'Charities deserve the best'

Ten million of us have used the JustGiving website to donate to good causes. Its co-founder says that being dynamic is as important as being kind
The botanist who hunts for giant trees at Kew Gardens

The man who hunts giants

A Kew Gardens botanist has found 25 new large tree species - and he's sure there are more out there