Are UK banks killing the economic recovery?
07-31-2010
Are UK banks killing the economic recovery?
Time for a spot more of Britain's favourite sport? Yes, indeed; next week brings first half results from virtually all the top UK banks, and therefore abundant opportunity for renewed banker bashing fun.
By Jeremy Warner
If it gets in the way of the economic recovery, does anyone really care? Bloody minded retribution is still preferred to constructive restoration. It may take further hardships for sense to prevail.
But lest it be forgotten, the taxpayer too, never mind the wider economy, has a rather large vested interest in the continued recovery of the stricken banking sector. Taxpayers have got £60bn invested in Royal Bank of Scotland (RBS) and Lloyds Banking Group (LBG) alone.
With Europe's sovereign debt crisis apparently abating, the stress tests over, and the removal of some at least of the regulatory uncertainties that have been hanging over the banking sector, both the RBS and LBG investments are again within a whisker of being back in the money.
This doesn't mean that UK Financial Investments, which holds the stakes on the taxpayers' behalf, can think about divestment. There's still a long way to go before we reach that point. The Banking Commission, which is examining whether the banks need to be further broken up, must report first, and that won't be for another year.
If root and branch structural reform is recommended and enacted, it could be years before the banks are in any fit state for re-privatisation. In seeking to appease uncle Vince, the Treasury has created a potentially uncontrollable rod for its own back and pushed payback time into the indefinite future.
The other big uncertainty is new capital adequacy rules from the Basel Committee on Banking Supervision. The Committee backed away from some of the severer aspects of these changes this week, but again, nothing can be done in terms of divestment until the new rules are set in stone, which won't be until November at the earliest.
By historic standards, UK banks remain hugely undervalued. They used to trade at several times book value; now the two part nationalised banks are at or below it. There's also a big discount relative to some European peers.
Given the recent, near death experience of the UK banks and the still significant risk of a double dip recession, this might not seem so odd. Even so, the pricing differential with comparable European lenders seems hard to reconcile with the fundamentals.
Last week's stress tests showed that even the two part nationalised banks were significantly better capitalised than most European counterparts, as well as a good deal further down the road to full bad debt recognition. So how come they trade at a discount?
To my mind, the main reason for this valuation anomaly is confusion at the heart of public policy. What does the Government want from Britain's banks? On the one hand, policymakers are reluctant to promote fundamental change, for this would interfere with the return to normality, both in terms of a functioning financial system capable of renewed credit creation, and the sort of valuations that would allow taxpayers a profitable exit.
But on the other, they demand root and branch reform, a banking system so hedged around with checks and balances that it would never again be able to damage the real economy on the scale seen in the past three years. The two goals are not easily reconciled. Vince Cable, the business secretary, demands that at one and the same time banks both lend more and further deleverage to restore balance sheet health. You cannot do both without oodles more capital, which for the moment markets are not prepared to provide.
As things stand, the pressures are still very much for further balance sheet shrinkage. Never mind the looming new capital requirements; provided the transition period is long enough, these can be managed. Much more worrying is the approaching funding gap, which threatens, if we are not careful, a whole new credit crunch.
According to the Bank of England's last Financial Stability Report, UK banks will need to replace between £750bn and £800bn of maturing term funding and liquid assets by the end of 2012. That's an awful lot of lending that needs to be refinanced. Many banks will choose to withdraw credit in preference to finding scarce and expensive funding alternatives.
In any case, after a period of recovery, the quantity of credit in the UK economy is again shrinking. Bankers blame absence of demand and refute charges of lack of availability. Both assertions are partly true. Demand has certainly shrunk. Many larger companies, having cut costs, reduced inventories and widened margins through the downturn, find themselves flush with cash. They've been paying down debt, or finding alternative sources of capital.
The problem is rather in small to medium sized enterprises, where the cost and terms of credit have in many cases been significantly tightened.
Yet far from amounting to an unjustified squeeze, this process is in fact just a return to reality. It was the easy money of the boom which was abnormal, not present, more straightened lending conditions.
The situation might be improved, as Mervyn King, Governor of the Bank of England, pointed out in evidence to the Commons Treasury Select Committee yesterday, simply by requiring banks to pay smaller bonuses and dividends. This ought in time help rebuild both capital and lending. New entrants without the legacy of balance sheet impairment might also help. And as Mr Cable has suggested, it might be possible to encourage alternative sources of finance outside the banking system through a revival of regional stock markets and the like.
All this is no doubt worthwhile thinking, but as it happens, credit expansion is by no means essential to economic recovery. The velocity of money, or the number of transactions taking place in the economy, is the more important ingredient.
As things stand, this is still exceptionally low. Once a strong cyclical recovery is established, the credit will follow naturally. What's more, we don't need more lending to underpin an investment led recovery. Bigger companies account for the bulk of investment and they have all the money they need.
Sorry to side with the bankers, but it is uncertainty and lack of demand, not of lending, which is the main issue here.
4 people
We are very good at sweeping the C**P under the carpet but in finance there is always a bottom line and our figures just do not add up.
Sorry but the people in Westminster just do not have a clue but what do you really expect when they make someone like Prescott a Lord!.
We are now told we are all in it together but something tells me that like the Titanic those on the upper decks will be the very last to get their feet wet!.
2 people
"But, the banks would still have been forced to rescue the losers with government cash."
If banks' investment arms had been properly separated from the retail side, the shareholders and investors in the investment entities would have lost the lot - but they would have known what rthey were investing in - and the retail banks would not have needed bailing out. Why would the governments "have been forced to rescue the losers"? Unless, of course, the investment banks were paying off the politicians (aka supporting their election campaigns)!
As you say, there's hardly a politician who truly understands the fine points of international finance. Why should the public expect them to be able to utilise their taxes rationally in these cases - it's all about re-election, isn't it?
UPDATE 2-Schwarzenegger declares California fiscal emergency http://www.reuters.com/article/idUSN28221765201...
The entire state is sagging from the 500 bln dollar pension fund on a puny 84 bln dollar budget with a 20 billion dollar deficit and nobody can be fired or furloughed. This is a terminal episode were the government employees and elected officials will demand everything in the state for their future and current comforts.
The 'solution' will be to raise taxes! What else?
This is how progressive and socialistic governments operate.
If you have something of value then watch out. Whatever it is it can be taxed.
1 person
" Why would the governments "have been forced to rescue the losers"? Unless, of course, the investment banks were paying off the politicians (aka supporting their election campaigns)!"
Let us suppose that there is a private to business wealth ratio of 5:1 [57 trillion for citizens and 15 trillion for business are correct for the US] and some private banks went down because some 5-7 trillion dollars vanished in the real estate bubble bust. It matters not how the losses are distributed between private investment banks and commercial banks. What matters is that a 5-7 trillion dollar hole was blasted in the banking system and there is no way to rigidly insulate one banking bunch from the other. Money from deposits will flow from the sound banks to make up for loses elsewhere in all cases.
No bank can stand a run and you can insure 1 bank but not 100 banks because the backup capital is just not available. So, any banks with deposits or demand accounts will lose money and then they will fall below their reserves and they are insolvent. The ONLY solution here is for the central bank to wire money to the capital reserves of the banks that are failing. There is NO other way for the bank to escape default. When they do accept government funds then they become zombies and supplicants and hope to build up lost assets with very low profits on accounts and mere check shuffling.
Politicians have to scatter around the glittering nostrum that they can isolate the greedy capitalists from the good people of the land and isolate losses from mistakes and greed from the good citizens who are deemed noble and sincere, hard working and industrious since they are not rich. Thus the fairy tale of two parallel universes springs forth in the minds of politicians who 'look after the little guy" and “ can control the rich and greedy” and assorted nonsense.
We had a mechanism in place to handle this sort of thing and it was called bankruptcy. The penalty for a failed bank would be a Chapter 7 auction of all assets and the government switching all accounts over to another bank and backing up the new bank for the loses. Thus, the stock holders and management would lose everything. GM should have worked out that way but, no, the government had to step in and mangle the very old process of allowing secured bond holders to get the first dibs on assets and then, if anything is left, bringing in other creditors. No, the government decided that the bond holders should take the haircuts and that the unions should get protection on their retirement and medical accounts with a free fat chunk of the business for their grand participation in the previous national election.
Thus a lousy and poorly run business lost 80 billion dollars in a competitive market over a decade and it was rescued from Chapter 7 by the government and was propped up with new loans and such to make new electric cars that suited the political tastes of the government. This maneuver, along with using Fannie Mae to offer zero down mortgages to people with no credit for votes even if illegal is the way these politicians think and act.
Meet the Real Villains of the Financial Crisis—the CRA [Community Reinvestment Act], “Affordable Housing” and the US Government
http://rycksrationalizations.blogtownhall.com/2...
The banking system is just a political lever for the elected officials and bureaucrats to pull and push for financial and political gains. Those who build up wealth then do so at their peril because many eyes covet private wealth and most of those eyes are in the government.
rycK [a 5th generation Californian in exile]
Comments to: ryckki@gmail.com
"But on the other, they demand root and branch reform, a banking system so hedged around with checks and balances that it would never again be able to damage the real economy on the scale seen in the past three years. The two goals are not easily reconciled. Vince Cable, the business secretary, demands that at one and the same time banks both lend more and further deleverage to restore balance sheet health. You cannot do both without oodles more capital, which for the moment markets are not prepared to provide"
It becomes clear that this is a political process and not merely some punishment for bad banking behavior. If banks are supposed to handle deposits and shuffle cash around for a small fee then those banks should have been structured, commissioned and regulated as such. But, this not where it ends since banks are locked into a risky financial time frame: they take in deposits on a monthly period and loan out a portion of those deposits for 2-30 years at some interest rate. That is a slim margin and fraught with the nightmare that a run on any bank quickly extinguishes those famous reserves and the bank enters zombiehood if and when it is rescued by the printing presses of the state bank.
If banks can be traders and deal in all sorts of swaps, CDOs, hedging [Iceland!] or other then those banks might be given a different charter.
Glass-Stegall-- [http://en.wikipedia.org/wiki/Glass-Stegall_Act] was complicated as it appeared to put some safety net around the banks to prevent failure and anointed the system with the FDIC agency. A modern version of this is the Volker Rule that roughly repeats most of the wishes in G-S.
Now, this appears to be a fine political solution to an economic or business problem although politicians are the least capable persons to structure this.
If you split these current banking functions into two pieces and regulate one as just a check-shuffling enterprise at low profit and high risk you have accomplished nothing. If the traders in swaps and CDOs make another mistake it is difficult to show that the banks would be insulated from financial shock. This is because if investment companies [ex banks or parts of former banks] suffer some major losses then the deposits, loans and other connected instruments in the banks are also in jeopardy. If, indeed, those loses lead to the need for some quick cash to cover shorts or other investments note that the banks will experience a fast drain of their deposits and that jeopardizes the cash reserves so the banks can become insolvent even if they are not handling the risky transactions in house.
A reading of two recent books: Ascent of Money by Niall Ferguson’ and the newer book This Time is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth Rogoff show, very clearly, that the vast majority of governments cannot manage finances with any long term competence. They make enormous mistakes as outlined by 1957 book: War and Aftermath 1914-1929 by Pierre Renouvin that offers us a critical but objective scrutiny of the political and military actions of various government agencies starting in the 1890s and leading up to August 1914 where most world stock markets suddenly shut down for months; this history is enlightening. Ref: The Preposterous Notion of ‘Fixing’ the Derivatives Market and Other Follies.
http://rycksrationalizations.blogtownhall.com/2...
These three books follow, in part, some 5-8 centuries of bond and banking histories with the final conclusion in hand: It matters not how you attempt to control banks, they will crash if the system crashes. Period.
The ‘regulation’ of banks is just a political perk for winning some elections and nearly every government since the 14th century has used the banks for military and political purposes. This ‘regulation’ process allows political parties to favor their constituents such as Cap and Trade, military hardware, social programs and such. Fannie Mae, as an example of a political bank extension, is fatally bankrupt after just tossing money out the windows to the ‘poor’ and now they require periodic rescues in the range of a half a trillion bucks or more.
Moving around the pieces on the geopolitical financial chess board does not redefine the process of investment or savings and does not guarantee financial safety for anyone. The regulation process and political stimulation of the economy with bank loans and such merely service the current political whims of governments, shown to be incompetent in these matters for centuries.
No matter what the divisions and rules, the banks and their counterparts however named or aligned will become the fawning pawns of the politicians in power and we all know politicians will use this power to buy more votes. The most probable outcome of some revampment of banks in one economic sector of the globe is to make that sector less efficient in producing jobs and trade.
Thus, overregulation of the banks will produce opportunities elsewhere [Japan is now going global and they have a fat reserve of more than a trillion dollars] so severe duties and penalties for bankers will drive the talent away from London or New York and the economic power of the banking systems will flow away to those more competent.
Governments are now tinkering with nostrums on ‘fixing’ the derivatives markets that now runs at some 600 trillion dollars while the Depression of 2006-2020 wiped out only 15 trillion at best and that is only a few percent of that market. What would have been the result if the derivatives markets were not in force at the time. A 2.5% in wealth loss seems but a droplet in the pond of things at this magnitude and nobody can show us that this was not even the core problem of the meltdowns nor can they even come clean on the location and net present value of the toxic assets. The politicians cannot lay blame on the government-inspired housing bubbles bursting from synthetic demand based on politics. They blame something they think they can control. When bubble burst wealth vanishes and no government can print up enough money to fill that hole without perturbing the entire system.
Governments were content to rake in excessive taxes on banking business operations until something went wrong then those rules, regulations and structures conjured by governments needed some radical change. I wonder how many centuries it will take until governments can run a bank or handle the investments of their citizens.
rycK [a 5th generation Californian in exile]
Comments to: ryckki@gmail.com
2 people
Until the financial crisis, there was a constant battle to make ever-increasing profits and also to increase the size of the banks. Why? Because of the misconception that 'Big' is synonymous with 'Good and Safe' – i.e. the bigger a bank's balance sheet the more assets it has to back up its business. We have found out how wrong that concept is. If the value of the assets that secure a bank's lending are stable or increasing at a reasonable and moderate rate, that is fine. But if banks rely on security that is increasing immodestly (a bubble) and keep on lending additionally against that security without a 'what if' backup plan, the risk to both shareholders and the bank's normal customers also increases immodestly. That happened and the result was panic when the bubble burst because there were no backup plans, let alone capital reserves that had been put aside to hedge against the risks.
As has been said, investment banking is a gamble. As long as it is profitable, that is fine, but the results of inadequate assessment of the risks involved expose everyone to almost unquantifiable losses when things go wrong. Unfortunately, in their drive for more and more profits and in the light of what they saw as inadequate growth in their retail banking activities (which are geared to the general economy), banks relied more and more on their investment banking side to provide happiness to their shareholders while putting their bread-and-butter customers at increasing risk.
I fully agree that the investment arms of banks should be hived off and should be subject to much tighter regulation as separate entities to their owners. The risks in retail banking are well known and have been quite profitable for long enough. If banks must satisfy their lust for profits and market size through investment banking, that is what needs regulating and treating by the markets as separate entities which, if they fail, can have no bearing on the owning banks' retail activities – i.e. investment banks should be allowed to go insolvent at the sole risk of the shareholders.
If that were to be put in place, I would have no objection to large salaries and bonuses being paid to the investment banks' staff on the basis of performance. Bonuses should, however, not be automatic but should be payable, say, two years after the end of an employee's employment contract so that any losses for which the employee is responsible should adversely affect the amount of bonus he receives.
All this whingeing about the banks being the ogres of society must stop, the sooner the better. All that needs to happen is that they need to be forced to restructure their risk exposure to minimize the risk to their retail banking side. Let retail banking get back to normal so that it can do business in the time-honoured way and at more normal pricing than is being forced on them at present.