Leading article: Ministers should concentrate their fire on the banks

The Government must act radically to unblock the credit markets

The debate in the world's capitals this week has been dominated by the prospect of fiscal stimulus plans designed to ward off a disastrous global slump. The incoming US president, Barack Obama, has promised to create jobs through such a package early next year. The European Commission yesterday released details of a €200bn Europe-wide plan for 2009, and our Government unveiled its own contribution to that on Monday, with a cut in Value Added Tax.

But there is a danger of governments missing the bigger picture of this crisis by concentrating on this particular set of policy options. A fiscal approach to stimulate spending is all very well, but equal attention needs to be given to the effect of monetary policy. To put it simply, if the banking sector continues to starve our economies of credit, all the tax cuts and spending increases governments can muster are likely to prove entirely useless in stoking demand.

That danger is especially evident here in Britain. Despite a drastic 1.5 percentage-point cut in interest rates by the Bank of England last month, and the prospect of more cuts to come, high street banks are desperately hoarding cash and cutting back on the provision of credit. Their protestations that they are maintaining lending levels are wholly unconvincing. Sir James Crosby's report on the mortgage market for the Treasury this week forecast that, on present trends, there will be no new net lending to the mortgage market next year. That means pain for many homeowners. But small- and medium-sized businesses are under most pressure from the credit squeeze. Many perfectly viable firms are in danger of going to the wall because they face punitive new credit terms from bankers.

In one sense, this is a rational response from the banks. They are intent on shrinking their balance sheets and building up capital reserves because they fear a host of write-downs still to come on bad investments made in the boom years. But what is rational for individual banks is insanity for the wider economy. If small businesses go under, unemployment will shoot up, increasing the number of home repossessions and sucking ever more demand out of the economy.

The question is what can be done to halt this dangerous squeeze? This week, the US Federal Reserve unveiled an $800bn package of public money which it hopes will help to unblock the American credit markets. The US government will buy up mortgage-backed securities from banks as well as other private sector loans. Our own Government should consider following suit, especially if the measures have a dramatic effect on easing credit conditions across the Atlantic. Another option is for ministers to guarantee lending made by banks to small businesses and homeowners, and they are considering this.

That is all carrot for the banking sector, but there must be stick as well. Our Government has a major shareholding in these lenders. In several cases, it is soon likely to have a controlling one. Ministers must use that power, through boardroom appointments, in the best interests of the economy and the country. Those interests are best served by forcing banks to maintain lending to the wider economy, no matter the effect on balance sheets. The alternative is to see a recession turn into a prolonged slump.

We must be in no doubt: the situation is only likely to get worse in the credit markets without state intervention. Ministers need to realise that haranguing banks from the sidelines is not going to deliver. They need to get their hands dirty.