Belfast Telegraph

Sean O'Grady: Banks don't want to lend and we don't want to borrow

What will drive the economy in the future? In some ways this is a daft question. In a market economy the engines of economic growth generally ignite spontaneously.

Few, for example, who surveyed the twisted wreckage of British industry in 1982 would have predicted that an obscure spin-off from the old Racal company would be one of the great growth stories of the next couple of decades. Yet that is indeed what Vodafone became.

You've probably never heard of what will be our biggest plc in 2030. It might have only just appeared on Dragons' Den.

Still, we can make a few shrewd guesses about what won't be offering much of a boost anytime soon; the public sector, obviously, and the banking sector.

The banks themselves may well return to some kind of health and normality, after a long period of convalescence. But that very process of convalescence means that they will be offering precious little support to the wider economy.



Every time you hear some random upbeat fragment of economic news you must intone to yourself inwardly: "the credit crunch is still on, the credit crunch is still on, the credit crunch is still on" until all false optimism has been leached from your persona.



The bald news from the Bank of England's latest Trends in Lending report is that the supply of credit to the real economy fell again in the second quarter of this year. Fell. Not stagnant or just dragging itself back up again. Fell. In June alone, it declined by £3.5bn, an acceleration of the £2.2bn and £1.1bn falls in previous months. Inured as we are too such developments, it is still bad.



Lending has been falling more or less continuously since the autumn of 2008. Lending to non-financial corporations (which removes the distortions of inter-bank activity) is down from a peak of £503bn in September 2008 to £472bn now. Not such a big fall, except that normal economic growth implies an extension in bank lending, as cause and effect of expansion.



Now you may have heard it said that the decline in bank lending has been partly offset by an increase in larger corporations raising capital directly from the markets via corporate bond issues and share issues. Ironically enough the big banks were particularly successful in raising new equity last year. Since the financial squalls of the spring the capital markets seem to have dried up. The pausing of quantitative easing at £200bn may also have had something to do with that; it was, after all, designed to raise asset prices and make it easier for companies to raise funds, which it did, for a while. Since many firms will have sated their thirst for funds last year some fallback might be natural, but there is no doubt that the markets have grown more nervous and larger companies that wanted to raise cash may now not be able to do so. Like bank lending, capital issuance has gone negative.



You may also have heard it said, by the banks in particular, that the reason why lending has shrunk is that firms and individuals have less appetite for debt. There has been a lot of argy-bargy about whether the banks aren't lending because they don't want to, or because people don't want to borrow. The Governor of the Bank of England told the Treasury Select Committee last month that "for the banks to say there is no demand for credit is not an adequate response to what is happening." Tough talk.



Yet the banks' claim that there is now a reduced demand for credit must have some truth attached to it. Anecdotal evidence tells us that everyone is vastly more wary of debt than they were a few years ago.



Confidence, that hot-house flower, has wilted under the frosts and harsh winds of successive financial crises, rising unemployment and, now, an emergency Budget that seems to have scared us witless before the first substantial cuts are even made. If you think you're about to lose your job, you're unlikely to want to take on huge new burden of debt at what the Bank of England euphemistically calls "elevated spreads". Or even if credit were cheap.



So small businesses may not have the appetite for loans and overdrafts they are sometimes supposed to have – yet we also know that the contraction in the banks' lending books and balance sheets is real and deliberate and has hurt them. It's an inevitable consequence of the banks rebuilding their capital, liquidity and profitability. It's true that the banks dish too much out in the way of bonuses and dividends, and thus could cut those and lend more, but even that claim may be exaggerated. After all, they need to pay bonuses to attract the staff they need, and they have to offer shareholders a return on their equity.



The debate is becoming jesuitical. Are the banks too nervous to lend to us, or are we too nervous to borrow from them? Either way it is a bad omen.



What has been much less remarked during the crisis – three years old now – is the way that bank lending wasn't that energetically supportive of the real economy even in the boom years. An analysis of the quarterly lending figures for the decade until things started going into reverse in 2008 shows that the banks did increase the supply credit to the economy every year – but that much if not all of the expansion was channelled into the essentially futile activities of the real-estate world.



The latest data shows that property is now leading the charge downwards, having been relatively unscathed in the earlier phase of the crisis. Real-estate loans tend to have a longer maturity than others, and the dire state of the property market recently may have pushed some banks towards forbearance. So a lag was inevitable, and one reason why the one dog that never barked during this long crisis was commercial property. That may not last forever.



On last thought occurs. If the Bank of England now had its "macroprudential tools" and decided that the supply of credit to the economy was indeed too slow, what would it do? It might relax the banks' capital and liquidity requirements, but that will not work if people and firms are disinclined to borrow anyway. Like low interest rates, macroprudential tools become ineffective in a world without confidence. And that is what is really wrong.

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