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13 Jul 2012

Many carrots but no stick for British banking

You won’t find the word “Libor” mentioned anywhere in the documentation for “Funding for Lending”, the joint Treasury – Bank of England initiative to try to kick-start UK private sector lending and borrowing.

The Bank of England has chosen a different “reference rate” as a measure of banks’ core funding costs. But the issue of trust and coercion between banks, the government and the Bank of England looms large.

Put simply, if Sir Mervyn King can arrange for Bob Diamond’s demise at Barclays, even though he was cleared of personal wrongdoing over Libor, why not exercise a little more coercive power over banks lending money into the real economy? More stick and less carrot, one might say.

The shocking scale of the problem is illustrated not just by our channel’s Bank of Dave programme, but by this graph:

Boom time annual credit growth of sterling loans to British households and private businesses (not other banks/ financiers) was a heady 10-12% in the bubble years, but was no less than 8% even in 2000.

In 2009 it collapsed, in 2010 and most of 2011 it was negative, and having tipped positive at the end of last year, it has fallen back as businesses, consumers and banks retrenched in the face of the Eurozone crisis.

For the Government Funding for Lending takes its three-pillared approach of “structural reform, fiscal conservatism and monetary activism” out to its maximum. It is genuinely Plan A-plus.

It is striking though how low the bar has been set. Essentially this scheme is a little like the European Central Bank’s bazooka of last December (the LTRO), but made conditional on more lending to the “real” British economy.

It is elegantly designed to work with the grain of market incentives in the banking system.

The more net lending, that is genuinely additional (ie not the slightly flaky Project Merlin definition that allowed the rollover of credit facilities to count as a “new” loan) the greater a bank can use the facility.

The more it increases lending the lower the charge will be to use the facility. This is probably the biggest ever experiment of the “Nudge” theory of using market-based incentives.

It should see tens of billions of pounds more UK lending. But the relevant question is: “more than what?”.

Many will find it shocking that already bailed out state owned banks will get further funding subsidies worth tens or hundreds of millions of pounds, even if lending falls over the next year by more than 5%.

The rationale is that state-owned banks are under instruction to shrink their balance sheets, so in this instance shrinking them by less than would have otherwise been case is counted as a “win”.

It is reasonable to ask why on earth this whole circus with what are state-owned banks should not be replaced by direct orders to lend more? The answer is that we still cling on to the hope that the stakes in these banks can be sold at a reasonable price.

The Bank of England will be publishing league tables of FfL banks and their performance starting in December. This will also “nudge” them in the right direction. Might some sort of link to bonuses have been plausible?

The opposition critique of this scheme is that there is a crisis of demand generally as well as supply of credit. The delay to fuel duty rises was a small admission of this from this Government.

So faced with the onslaught of an aggressively de-leveraging corporate, household, and government sector, the Bank and the Treasury have offered some welcome carrots to persuade banks to not decrease lending so much.

It is innovative, and bold, and unique in the world. But I’m left wondering if post-Diamond British banking might have needed a little more stick as well as these welcome carrots.

Follow @faisalislam on Twitter.

Watch Faisal Islam’s Channel 4 News story on video: http://www.channel4.com/news/us-warned-bank-of-england-about-libor-fixing-in-2008?-p

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