Dominic Lawson: When in doubt, blame the banks

Bear in mind that not all of us are borrowers; millions of us are also savers
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The Independent Online

When the entire political class is united on a single issue, you can be sure that it is largely mistaken: the more conventional is the wisdom, the more certain it is to be based on ignorance or mere fashion.

This is well illustrated by the concerted attack on the banks' lending policies from across the political spectrum. It is, they all agree, an unmitigated outrage that our banks are not passing on in full the recent cuts in the official Bank of England rate – a howl of rage only amplified by yesterday's decision by the Bank to cut its rate by one and half percentage points to 3 per cent.

The shadow Chancellor George Osborne yesterday called on the banks to pass the cut on "in full" to businesses and those with mortgages. Two days earlier, Peter Mandelson, in his silkily menacing fashion, observed that: "We are taking very strong action... if it appears that the banks are standing in the way of what the Government is doing then I think many banking customers are going to be asking difficult questions of the banks." (Lord Mandelson seems to have forgotten that the Bank of England's decisions on rates are supposed to be taken independently of Government, which is even more menacing).

Meanwhile, the chairman of the Commons Treasury Select Committee, John McFall, declared that: "Banks and building societies have been defying the laws of arithmetic by not passing on interest rate cuts to customers."

I had always imagined that it was impossible to defy the laws of arithmetic, but we get Mr McFall's drift: if the Bank of England cuts its rate by 1.5 per cent, then the commercial banks must cut the rates of all their products by exactly the same amount. I am afraid that this is almost as untrue as 2+2=5.

Take, for example, the most politically sensitive area, the mortgage market. About half of all mortgages are fixed rate: borrowers will pay the same until their term comes to an end. They don't suffer when the official rate move rapidly upwards, so they can't expect to gain when it moves in the opposite direction. A further 40 per cent of mortgages are "tracker" deals, under which both lenders and borrowers have contracted to follow the movements up and down in the official lending rate: in these cases, it's not a question of "urging" the banks to "do the decent thing" – it just happens automatically.

That leaves only 10 per cent of the market on variable rates, where it is true that the lenders have some discretion. It is also true that in recent months about half of the banks have used that discretion not to pass on in full the cuts in the official rate. Their reasons for doing so have nothing to do with any desire to be able to continue to award themselves big bonuses, whatever the chimps in the Westminster zoo might be chattering.

First of all, the most important determinant of what banks are able to charge borrowers is not the official Bank of England rate, but the cost of money in the wholesale market. This has been significantly higher than the official rate for many months now, which is what happens when banks are worried about the risk of default by other banks. It's true that the taxpayer-funded recapitalisation of three of our biggest banks has eased this panic, but doubts about the financial institutions' own creditworthiness have not disappeared.

Next, ask yourself why it is that so many of our banks had become so unstable in the first place: it happened because they had "mispriced risk". That is to say, they had lent money at dangerously low margins, thus ensuring that their own capital reserves were devastated when the collateral on which they had based their loans suffered steep falls in value. This process is still continuing, which is why some of the banks have needed to take up a not especially attractively-priced offer of funding from the taxpayer: observe that the Treasury is charging 12 per cent a year for this money – which hardly gives it a platform to demand that banks themselves lend at generous terms.

All the banks are now doing whatever they can to restore their capital reserves to levels which once would have been deemed essential, before the fashion for high-wire off-balance sheet financing drove some of them – notably Northern Rock – into meltdown. Shareholders will do only so much to support such fundraising: the banks also need to generate profits to supply the new capital they desperately need. This in turn can only be earned in the usual way: by banks charging a higher price to borrowers than they pay to depositors. In the circumstances now prevailing, it is neither surprising nor inappropriate for that margin to be quite wide.

I can see that this is politically embarrassing for the Government, which seems to think it has a deal with the banks who have taken the Treasury shilling that they would continue to "make credit available at 2007 levels". Yesterday, the Chief Secretary to the Treasury, Yvette Cooper, said as much on BBC Radio's World at One, reminding the banks that "they have signed up to conditions on the availability of credit".

Since neither the Treasury nor the banks have seen fit to tell us exactly what those conditions are, we are little the wiser. I suspect that the banks were careful to retain absolute freedom in the future pricing of credit, in which case the Treasury cannot complain of anything other than its own inability to read the small print.

If the Government continues to bully the main clearing banks, perhaps those organisations might turn around and point out that Northern Rock, which is entirely owned by the taxpayer, has been repossessing defaulting borrowers' houses at about double the rate of the industry as a whole, and has also been increasing the cost of new products. If the British Government really wants to set a trend towards easy credit – as if that hadn't been the problem in the first place – it should do so with a bank it owns, rather than bully those it doesn't.

It might also bear in mind that not all of us are just borrowers; millions of us are also savers. The politicians should not forget that we too have votes.

d.lawson@independent.co.uk

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