Why capital rules could limit the impact of new competition in banking
The new TSB bank was finally launched yesterday. The spin-off of 631 branches and 4.6m customers from Lloyds means that the UK now has the first new major competitor to the existing banks since the start of the financial crisis. And when RBS spins off 315 of its branches, Britain will have a further mid-size competitor.
The arrival of new competition is timely, given that the seven day switching guarantee comes into force this month. Even if we exclude the Co-op Bank, which is obviously going through some significant issues, the UK will have seven mid to large banks competing for business.
But while this should provide the competition that many have so dearly sought, will it do anything to improve the supply of credit? There has been some improvement, care of the Funding for Lending Scheme (FLS), in the supply of credit to the mortgage market. FLS has lowered the cost of funding, making housing more affordable, while the relatively low capital cost for mortgages means the banks have been able and willing to supply the credit.
But in business lending, credit remains tight. The now departed Bank of England governor Sir Mervyn King must take much of the responsibility here. He chose to ramp up the capital banks were required to hold (through the stress test implemented earlier this year), and then imposed a leverage cap much earlier and more stringently than required under Basel III. While some banks, like RBS and Lloyds, were forced to raise capital or shrink their loan books to meet the stress test, others such as Nationwide and Barclays suddenly faced the prospect of raising capital to meet the leverage ratio. It now appears that Nationwide will be able to avoid raising capital, but both it and Barclays will be more constrained than would have otherwise been the case. Ironically, it was Barclays and Nationwide that Bank officials previously referenced when they said better capitalised banks were growing their lending books.
Let’s hope new governor Mark Carney will at least think about the impact on credit growth of making banks ever safer. Little noticed at the time, given the debate about forward guidance, was Carney’s decision a fortnight ago to reduce the amount of liquidity banks were forced to hold by the Bank of England. We recommended this earlier this year, as it should allow banks to replace liquid but non-productive assets like gilts with new loans. It is a very good start.
But the capital Taleban (as Vince Cable calls them) remains a threat, as seen in comments from Sir John Vickers yesterday. He argued that capital ratios should not stop at 10 per cent but should probably be 20 per cent, and that leverage should be capped at 10 times not 33 times. We can only hope that the chancellor and Carney realise that such a prescription would result in another decade of no new credit supply to the economy. It is neither necessary nor advisable to go to such extremes in a modern economy.
We now have enough banks to generate competition and credit growth. But the chancellor and Carney must allow them the room to do so.