Banks' hidden subsidies worth £32bn a year

Britain's banks, which are preparing to announce multi-million pound annual bonuses to senior staff, are pocketing hidden subsidies worth more than £32.5 billion a year from the taxpayer, it was disclosed last night.

Research by the New Economics Foundation (NEF) think-tank calculated that the banks are receiving substantial extra support on top of the estimated £1 trillion direct and indirect aid already pumped into the financial system to keep it afloat.

Its conclusion will further heighten tensions within the Coalition Government over the future of the "big four" banks and the size of their bonus pots. The differences were laid bare yesterday as Vince Cable, the Business Secretary, pre-empted a Government review into their structures by demanding a "fundamental" and "radical" overhaul of their operation.

Days after Chancellor George Osborne agreed to end "banker-bashing" by ministers, his Liberal Democrat Cabinet colleague tore into the "offensive" bonuses being paid to staff.

Barclays, the first of the major UK banks to report, is set to reveal tomorrow that it will pay £2.5bn in bonuses as it unveils pre-tax profits for 2010 of close to £6bn. Its chief executive, Bob Diamond, is expected to say that he will not waive a multi-million pound bonus for the third year running.

Last week, the Government raised this year's banking levy by £800m to £2.5bn and signed the much-criticised "Project Merlin" deal, under which banks agreed to lend more to business and show restraint on bonuses. But in a new report, the NEF said the levy needed to be put in the context of "hidden subsidies" enjoyed by the banks.

The first it calls the "too big to fail subsidy". It said because banks are effectively underwritten by the state, they effectively save £30bn annually in borrowing costs that companies without state guarantees have to pay. It said: "Having concluded that our major banks are 'too big to fail', the Government provides a public guarantee, effectively insurance against going bust. In business terms, this gives the banks a huge commercial advantage over other firms in a market system. It reduces their risk. This means that they can borrow money much more cheaply than if they were not ultimately underwritten by the public."

The second hidden subsidy was dubbed the "make the customer pay subsidy" by the NEF, which calculated it to be worth at least £2.5bn a year. This represents the high rates of interest charged to borrowers by the banks in order to rebuild their capital.

The final subsidy comes from the Bank of England's "quantitative easing" programme, designed to stimulate the economy. The foundation says: "Merely for being passive conduits for this risk-free arrangement, the banks made more money, taking a cut of every trade. Here we find that they enjoyed a significant windfall, simply by being there, but that the failure to disclose sufficient information keeps the likely amount hidden."

The NEF said it was virtually impossible to put a value on the subsidy, although independent tax experts say it could be in the billions. Mr Cable gave a lukewarm assessment yesterday of the Project Merlin agreement, which he said had been "helpful" but was "by no means the finished article".

He told BBC1's Andrew Marr Show that an overhaul of the banks' structure was crucial to stabilise them: "There will have to be change and it will have to be radical." Asked whether that meant an end to retail and investment banking operations under the same roof, he replied: "It certainly needs to be fundamentally reformed."

Mr Osborne has struck a more cautious note, referring the issue to the Independent Commission on Banking, which is not due to report until September. The Chancellor is understood to be wary of splitting up the big banks.

Mr Cable described Merlin as "a glass half full" deal, before protesting that most people would not understand the "extraordinarily large bonuses" about to be announced by the banks. He added: "They effectively have a state guarantee and that's what makes the enormous payments so offensive."