Banking on a Bad Bank

The case for a fully functioning Bad Bank is now becoming very clear.  The recent news that Jim O’Neil is to leave UK Financial Investments, the organisation tasked to sell our publicly owned banks at a profit, without getting in striking distance of selling a single share in Lloyds or RBS is depressing beyond belief.  The last three years have been wasted as these two behemoths of the banking business are still miles away from full private ownership.  

The government took shares in these two failed banks in return for the massive amount of tax payer’s money that was required to prop them up in 2008.  The tax payer still owns over 70% of RBS and over 45% of Lloyds.  The marketing of these publicly owned assets has been terribly damaged by the muddled thinking at the Treasury and a mass of new and competing regulation these organisations are facing – Vickers commission, Dodd Frank, EMIR, Basel 3, Solvency 2, The closure of the FSA,  to name a few.  Whilst the banks are being used as a political football there will be no hope for the tax payer. 

Clearly regulation is required and all banks are going through the same pain so this alone should not be an insurmountable problem.  The real issue is that having bailed them out in 2008 the Government did not take bold enough action to tidy up these banks.  Rather than setting up a Bad Bank to manage the distressed and  risk loans and assets the Government asked both banks to manage the run off of bad debts an toxic assets themselves, as a results Britain’s most important lending organisations are unable to perform the function for which they were designed – lending money to reliable creditors.  This deadlock of broken banks unable to lend to a broken economy is tightening the liquidity trap in which we are now caught.

Alongside the failure of structural reform the government has, unwittingly, hampered the banking industry through its malfunctioning Monetary policy.  By keeping interest rates at artificially low levels, banks have lost profit margins and the reduced liquidity and make re-capitalisation impossible.  The other ‘benefits’ of negative interest rates caused by large scale Quantitative Easing have been rising inflation and the rise of Zombie companies (businesses barley able to keep their heads above water), both of which have a negative impact on our lending institutions.

The banking problem reflects back a wider issue.  The gently, gently approach to economic reform and deficit reduction have actually made things worse.  A monetarist strategy that applied positive interest rates might well have been the answer.  Higher interest rates would have resolved the banking crisis quickly, rewarded savers, managed down house prices, boosted banking activities and in return inflicted some marginal pain of borrowers.  If the George Osborne had taken this more Thatcherite approach to the crisis we would have had more pain in 2010 – 11 but we would now be on the road to recovery – rather than dead in the water.