These are dangerous times for British banking. So the politicians who are busy scoring points against each other in Westminster over the Barclays firestorm should draw a deep breath and look at the big picture, which, conveniently enough, was set out last week in the Bank of England’s latest Financial Stability Report.
This showed that the big banks have gone some way in the past two or three years to boost their capacity to cope with financial shocks. Their leverage ratios are down from a multiple of more than 40 in 2008 to about 20; the gap between customer lending and customer deposits has shrunk from a peak of more than £900bn to less than £200bn; and their holdings of highly liquid assets have tripled over the past four years. Relative to their balance sheet total, sterling liquid assets are higher than they have been since the 1970s.
All this provides some insulation from continuing strains, and just as well, since that’s where the good news ends. The potential problems start in the eurozone, where British banks’ exposure to sovereigns and banks in the most vulnerable countries is now down to modest proportions. But the picture looks much worse if you include non-bank private sector borrowers in these same countries. British banks are also heavily exposed to other institutions in the eurozone and could suffer badly if contagion spreads through the system. The French banking system is an obvious example: its exposure to Greece is equivalent to about an eighth of its tangible equity.
There are worries closer to home as well. Progress in rebuilding capital has slowed over the past 12 months and, because profit expectations are declining, there is unlikely to be much progress here in the near future. There remain some big question marks over parts of banks’ loan portfolios, most notably in commercial real estate, which still accounts for nearly half of all the big UK banks’ corporate lending in the home market and has made up a large part of their losses in recent years. This sector faces a big refinancing challenge, with about £50bn of debt maturing in 2012.
For all these reasons, share prices of the big UK banks, when expressed as a proportion of book value, are just about as low as they were at the darkest days of the crisis. At the same time, bank funding costs are rising and customers are paying the price. According to the BoE’s latest credit conditions survey, also published last week, “a further marked widening of spreads was expected across secure household and corporate lending in the next three months, as the elevated cost of bank funding is passed through to borrowers”. Foreign lenders, who accounted for half the loans to British businesses before the crash, are continuing to withdraw their funds, and net sterling lending to the UK corporate sector has contracted steadily since the start of 2009. There is always a debate about whether this trend reflects weak demand from business or constrained supply from the banks: the Financial Stability Report judges that weak credit growth has increasingly reflected reduced credit supply, at least when it comes to small and medium-sized companies.
So the outlook for financial stability has deteriorated and there is a risk of what the BoE refers to ominously as a “potential adverse feedback loop”: credit conditions tighten, the economy weakens, the quality of bank assets deteriorates – and credit tightens again. So the government’s various credit easing plans cannot come a moment too soon.
That’s the backcloth against which the Barclays disaster is playing out. What is needed is a serious debate about a matter of grave public interest, not the partisan political dispute of the past few days: there is nothing to choose in this respect between the tactics of George Osborne or of Ed Miliband. But the chancellor is right in one important area. The last thing that is needed in this period of systemic fragility is the long period of regulatory uncertainty that a Leveson-style public inquiry would make inevitable. The Independent Commission on Banking was established almost exactly two years ago to come up with the changes needed to strengthen stability and increase competition in the British banking system, and has done its work.
If the Libor scandal means that the required changes have to be tougher, so be it: that is the argument for a short, sharp inquiry. Going back to square one would, to put it mildly, be a serious mistake. The economy cannot recover in the absence of a stable banking system: nothing can be more urgent than that.
03.07.2012 - FT.com