“No, you can’t”. These are unfashionable words at the moment – and nowhere more so than in the banking industry.
While politicians were hoping for an outbreak of economic optimism after Thursday’s reduction in interest rates, our High Street bank managers were having none of it.
Nearly 24 hours after the Bank of England slashed the official price of money by a record-breaking 1.5 percentage points, only three of the 88 major lenders had said they would pass it on to their borrowers. In fact, only 30 of them had got around to sharing the proceeds of last month’s half-point rate cut. The fact they were much quicker to cut interest rates for many savers only served to rub in the message: No, you can’t have a cheaper mortgage. No, you can’t get a fairer rate on your savings. No, you can’t expect us to go without large profits and bonuses. Change is for wimps.
Well, let’s see about that. In scenes that would have been unthinkable only two months ago, the Chancellor of the Exchequer summoned the industry’s leaders to Downing Street on Friday and promptly pistol-whipped them into submission. Treasury officials were said to have waved press cuttings in their faces, pointing out that the word “banker” had become a popular term of abuse – and not just in rhyming slang. Out they meekly trotted, finally ready to cut their standard variable rate on most mortgages by the same 1.5 percentage points suggested by the Bank of England.
Uncomfortable as it is to watch this public tarring and feathering, it is important to remember whose fault it is. The banks just don’t get it. Their economic world changed this autumn (just as the political landscape arguably has now done so too). Yet many senior figures in the City continue to behave as if it were a temporary aberration; a regular swing in the banking cycle rather than a violent snapping of the rope.
Only weeks before, these same money men had been on their knees (quite literally, in some cases) begging for help. Having over extended their once-cautious institutions in the name of short-term profit, they were staring into the abyss. Since we could not afford to plunge into a financial dark age, we agreed to hand over £500 billion of taxpayers money (£2 trillion globally) in exchange for an understanding that the bankers’ behaviour would change. Nationalisation was not our choice; it was the only alternative to calamity.
What happens now is not about right versus left or the rights and wrongs of capitalism; it is about the survival of capitalism. If the public is going to continue to have faith in the merits of the market, it needs to be convinced that justice prevails. The least we can expect therefore is for bank executives to behave with the same awareness of the bigger picture that we extended to them. Passing on interest rate cuts is only one part of this new deal, but it is symbolically important. With the state yanking hard on one of only two levers it has to stop the economy derailing (the other being tax and spending policy) it does not expect the lever to snap off in its hand. To be told that the lever has broken because bank executives want to keep their short-term profitability up is a grave insult to every taxpayer who contributed to that £500 billion rescue.
This morality tale might seem oversimplified. What about the fact that Libor, the inter-bank lending rate, remains high, the banks say. What about the need to repair our balance sheets? What about paying dividends to pension funds? What about the 90 per cent of mortgages which are not on standard variable rate interest?
It is true that bank executives remain in an acutely difficult spot. The rate at which they are able to raise money in the wholesale financial markets did not fall as fast as the Bank of England moved its official rates. The rate for three month lending between banks dropped on Friday from 5.56 per cent to 4.50 per cent – still way above normal levels, given a base rate of just 3 per cent. Anyone raising money in the market at 4.5 per cent and lending it to a customer with an existing tracker rate mortgage (now at, say, 3.8 per cent) is making a significant loss.
Worse still, several banks have been raising fresh capital at far higher rates. Barclays, for instance, went to the Middle East for help last week and received new money at a cost approaching 14 per cent in certain cases. They had the choice of taking the Treasury’s shilling, but valued their independence too highly (the cynical view is that it allowed them to carry on paying large bonuses to investment bankers.)
Another reason this money is so expensive is that many of those with funds to invest still regard banks as a risky proposition. Equally, at a time when many households and companies face an increased risk of going bust, it is fair for banks to argue that they need to charge us a higher price for taking on that risk when lending us money.
All these points are true, but don’t let the small print bamboozle you. They miss the fundamental point that banks now have the explicit backing of the state. The cost might be higher than they would like it to be, but for now this source of support is immensely valuable. Instead, what this is really about is the level of profitability that banks and their shareholders can expect in return, especially during these exceptional times.
Of course we need to encourage bankers to return to profitability and independence in the long term, but, given what they have just gone through, most shareholders ought to be glad their banks are still alive. Their more immediate goal ought to be to keep the economy from contracting any faster than it is already. This, at least, is the one thing we all have an interest in.
Which brings us to the final argument wheeled out by those who seek to defend the behaviour of banks last week: if excessive lending and cheap debt is what got us into this mess in the first place, how can it make sense to force banks to carry on offering cheap mortgages now? Surely we can’t ask them to curb excessive lending and keep cutting the price of lending?
Once again, there is a grain of truth in this argument. The road back to normal economic growth will have to involve less dependence on debt. But the pace of change is vitally important: if banks swing too fast in the other direction and cut off all affordable lending to the economy, the consequences would be disastrous. We need to wean ourselves off gradually and carefully.
As I’ve argued here before, it is also vital that savers are properly looked after. This is partly so as not to punish the prudent while we reward the reckless, but it is also in the interests of banks to attract new, more stable sources of capital. Just as it is dangerous not to pass on the full effect of interest rate cuts to borrowers, there is a danger in being too swift to pass on the pain to savers. In fact, you can expect this to be the next battleground. An imminent government report on mortgages will almost certainly encourage banks to increase their reliance on savings deposits.
Neither of these of two prescriptions bode well for short-term bank profits, but there is a lot more at stake that simply funding next year’s dividend or bonus pot.
By Dan Roberts
Last Updated: 11:14AM GMT 09 Nov 2008
Source: The Telegraph