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Our banks 'have to lend more'

• Robert Peston
• 4 Jan 09, 01:09 PM

Those of you of a puritan nature may have come close to fainting this morning when the Prime Minister told Andrew Marr that our biggest banks may have to lend more than they did in the boom years rather than less.

"Is he totally bonkers?" you may have found yourself asking. "Surely it was excessive borrowing by companies and households that got us into this mess. So how can it make sense for the banks to lend even more?"

The answer, which Gordon Brown hinted at in a characteristic mumble, is that our biggest banks provided only a proportion of loans during the era when the debt bubble was created. And lots of the other providers of credit in that time of crazy lending are now out of the market altogether or have become much smaller players.

That's one of the major reasons why there has been a sharp reduction in the availability of debt-finance even for creditworthy businesses and prudent households.

And, to state what you all know too painfully well, it is the main reason why our economy is contracting so painfully.

Here's an incomplete list of banks that were major providers of loans that - for a variety of different reasons - are no longer the aggressive providers of credit in the UK that they once were: the Icelandic banks (you know why); Northern Rock and Bradford & Bingley (ditto); the finance arms of major motor manufacturers; Citigroup/Egg; Alliance & Leicester (absorbed by Santander); many of the Irish banks and their subsidiaries; the smaller building societies; the specialist mortgage lenders.

The collapse of Woolies told this story. Among the big lenders who demanded their money back in November, only one - Barclays - was British. And Barclays' exposure was smaller than most. The big lenders - GMAC, Burdale (part of Bank of Ireland) and GE Capital - have overseas parents.

So how much capacity has been taken out of the British lending market? Well that's what the Treasury and the Bank of England are desperately trying to evaluate - because it will determine the next phase in the Government's commitment of taxpayers' money to ensure that sufficient credit is available to viable businesses and households.

My strong sense is that the Treasury is moving towards a plan that looks awfully like the Tories' proposal for taxpayers' to guarantee a proportion of lending to business.

What's under consideration is an insurance scheme, whereby banks would pay a fee to the Treasury to reduce the potential losses they would face on lending to companies and also possibly to households.

Here's how such a scheme could work - though it's early days, so don't assume that the numbers I quote will be the ones the emerge as and when a scheme is announced.

The banks would retain liability for - say - the first 5 per cent of the loss on a loan. So they would retain a strong incentive to lend prudently. But the banks would be able to purchase insurance from taxpayers to cover the next 10 per cent or so of any losses on loans that went bad (and, in a severe recession, many loans would go bad).

Why would this encourage banks to lend more than they are doing at present?

There are two reasons.

First, the banks could take a bit more risk when lending, because the loss to them in the unlikely case that all the stinky stuff hit the fan at the same time would be knowable and manageable.

Second, with the state sharing the risk, the banks' capital ratios would look much healthier as their balance sheets expanded, because the formal regulatory risk-weighting of lending would be significantly reduced.

Of course, the corollary of all this would be a significant increase in the risks and potential losses carried by taxpayers. And as I said in my Christmas Eve note ("We are the banks") the line between the public and private sectors would become even more blurred.

As for the banks, if they took advantage of such a scheme, they would be under an unavoidable obligation to direct their incremental lending at the UK: they would have to massively increase the credit they provide here, and shrink the credit they provide in other countries.

To be clear, there's a lot of this going on anyway. Royal Bank of Scotland, for example, is scaling back its global ambitions and is rebalancing its business towards the UK.

And there, as they say, is the rub.

RBS's shift towards its home market is a microcosm of what most banks are doing all over the world. And as banks do their patriotic duty and direct their increasingly precious and scare capital resources towards their domestic markets, the amount of credit available in the world as a whole is being compressed.

What's going on can be seen as a partial retreat from globalisation in the financial economy. The scale and longevity of that retreat in this new year will determine all our economic fortunes, wherever we may be in the world.

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