Bank capital rules are holding back a credit binge – but also our recovery
THE RECENT run of better-than-expected economic data and the government’s Help to Buy scheme have sparked talk of a return to credit-fuelled boom and bust. Some have joined renowned monetary policy hawk Andrew Sentance, a former member of the Bank of England’s Monetary Policy Committee, in calling for interest rates to rise sooner rather than later. As house prices climb rapidly in London, others have speculated about another housing bubble.
This is, to put it mildly, a bit premature. The UK is experiencing the type of growth you would normally expect in the initial stages of a recovery, especially from a recession as deep as that triggered by the financial crisis. That crisis saw a peak-to-trough drop in GDP of a staggering 7.2 per cent. Current annualised growth of 3 per cent is only a boom by the standards of the very slow recovery of recent years. Yes, unemployment is also falling, but wage growth remains subdued. Otherwise, we would not be fixated on the current political debate about living standards. As for the housing market, there are pockets of price strength (and London has its own issues). But in the country more generally, the recovery in prices comes after five or more years of decline or stagnation.
Why (for now at least) should we be unconcerned about the chances of a credit-fuelled boom? As I have previously argued in this newspaper, one of the main reasons for our slow recovery has been efforts by the authorities – both the Bank of England and the Treasury – to force more capital on the banks. That is why, despite quantitative easing and the Funding for Lending scheme, credit growth remains so sluggish.
What credit growth there is comes from low capital-intensive lending like low loan-to-value mortgages. And this is also why the Help to Buy schemes are likely to prove so popular, since they enable borrowers (and the banks that lend to them) to effectively circumvent the capital rules. Why? Because the government deposit guarantee acts to lower markedly the capital required for the mortgage.
Lending to small firms, however, is still very weak because it remains highly capital-intensive. Moreover, regulators seem intent on forcing capital requirements ever higher. The Bank of England recently announced new stress tests for the banks next year, while part of the deal for the Bank signing off on the recent RBS restructuring was a commitment by the latter to a 12 per cent tier one equity capital ratio by the end of 2016. The new leverage ratio, introduced by former Bank governor Lord King in the dying days of his tenure, has already forced Barclays to raise new capital, and is likely to diminish Nationwide’s lending capacity. Finally, what chance is there of Co-op Bank going on a lending spree, as it shores up its capital? Next to none.
Economic booms tend to be a result of booms in credit. Against the background I describe here, there is little chance of that happening. I am not a particular fan of Help to Buy, because unless it can be coupled with the type of house building programmes put forward by my colleague at Policy Exchange Alex Morton, it will bolster prices. But it is not quite the threat many describe, and the Bank of England has been given the power to rein in the scheme should it look like it is stoking a bubble in the housing market.
In the short run, I suspect the stronger growth we have started to see will be sustained. Individuals and companies have used the period of very low interest rates to rebuild their balance sheets to the point that money can now be spent. Items, which people and companies have long been thinking about replacing, can now be replaced due to that increased financial strength. However, as long as it is largely self-financed and not credit-funded, it is likely to be self-limiting.
Despite recent pledges (including by RBS) to increase lending, the scope for banks to do so remains limited. We need to be worried about an unsustainable boom when – and only when – banks have reached sufficiently high levels of capital that they can start lending more aggressively, without worrying about the regulators. We are still a long way from that. So while Bank governor Mark Carney is a good deal closer to an interest rate rise than seemed likely when he took office, he should be able to keep his finger off the trigger for some time yet.