How the awful state of bank lending is hurting the economy

9:20 am - September 26th 2012

by Duncan Weldon    

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Yesterday, the Bank of England’s Paul Fisher gave an interesting speech today ‘Developments in financial markets, monetary and macroprudential policy’.

What I found especially striking was the chart below:

In the speech, Fisher spends quite a bit discussing the Government’s Funding-For-Lending (FLS) scheme in detail.

A few points stand out. First the Bank of England seems very reluctant to suggest that FLS will actually boost net lending, at best it may succeed in stopping net lending from falling.

Second, the overall success of the scheme will basically come to what the big banks choose to do:

The first point I want to make in reply is that banking in the UK is far from a perfectly competitive market. The six biggest lenders account for the vast majority of lending to UK businesses and households – and the seventh largest accounts for less than a third as much as number six. In large part the quantitative success of the scheme will depend on what these larger lenders do.

Third, FLS is something of a scatter approach to supporting lending – not targetted at where credit is especially constrained:

The FLS does not seek to allocate credit to particular parts of the economy directly – the Bank is not taking a view on this matter. But SMEs and first time home buyers in particular are thought to be credit hungry. Banks will collectively need to meet that demand if they are individually to make the most of the FLS. Not necessarily every bank will support every sector. But if the big firms don’t then the smaller banks will. We are relying on the pressures of demand and supply, and competition, to ensure that credit flows to where there is demand.

At least one bank is already using FLS funding to cut the cost of buy-to-let mortgages.

The FLS relies on the big banks, it may not address acute areas of credit shortage and it may not succeed in boosting net lending.

The British Business Bank announced by Vince Cable yesterday will be better able to target areas of credit shortage but is unlikely to be up and running for another 18 months and is of limited size.

The TUC has called for a far more radical appoach to getting banks to support the real economy – with proposals including a ‘proper’ state investment abnk to support SMEs and infrastrucutre, boosting the role of the Green Investment Bank, new regional SME banks, a greater role for mutuals and a shake up of the position of the Too BigTo Fail banks that dominate UK banking.

Implementing such a programme would help get credit following again.

A longer version of this post is here.

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About the author
Duncan is a regular contributor. He has worked as an economist at the Bank of England, in fund management and at the Labour Party. He is a Senior Policy Officer at the TUC’s Economic and Social Affairs Department.
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Reader comments

Excuse my dimwittedness, but I’m struggling to interpret the graph.

Have I got this right:

The rate of “lending growth” isn’t the rate of growth in the amount of money lent by banks every year (e.g. last year they lent £100bn, this year they lent £110bn, so that’s 10% “lending growth”).

Rather, it’s the rate of growth in the overall amount of debt owed to banks (e.g. last year banks lent £200bn, debtors repaid £100bn, and the overall amount of debt rose from £1000bn to £1100bn, so that’s 10% lending growth. This year debtors repaid £100bn, banks lent £100bn, so that’s zero lending growth.


Hadly a surprise….given that the recession was caused my too much debt, notably housing/mortgage debt and then government debt, it is reasonable to asusme that individuals are likely to try and deleverage as much as possible by paying down debt.

The corollary to this is that Duncan and co. are suggesting that the solution to the crash caused by the popping of a credit bubble is simply to inflate another one. Which is exactly what Greenspan, Krugman et al suggested post the dotcom crash……and look where that got us.

GO @1 –
“Rather, it’s the rate of growth in the overall amount of debt owed to banks (e.g. last year banks lent £200bn, debtors repaid £100bn, and the overall amount of debt rose from £1000bn to £1100bn, so that’s 10% lending growth. This year debtors repaid £100bn, banks lent £100bn, so that’s zero lending growth. ”


Tyler @ 2 –

Where we in a credit boom before 2008? Yes. Should we be hoping for bank lending growth of 15% again? No.

But what we have now is too weak credit growth.

I’d be more comfortable with a BBB making larger targetted efforts to support lending than a scatter gun ‘just boost credit’ approach.


Who is to determine the creditworthiness of these “targets”?

When the banks collapsed they didn’t have enough capital to back up their loans. So the government told them to start saving. If you’re saving then you can’t give it out. So it’s obvious why the bank’s have stopped lending – because the government has told them to. Left hand, right hand anyone?

I think that’s why the chart shows such a sharp drop in lending.

@3 Duncan

I’d argue we need some real creative destruction, where asset prices are allowed to drop (through deleveraging) to a level where the risk/return profiles look much more favourable for investment and confidence in lenders encourages credit extension rather than it being artifically pumped up by forced lending schemes and QE.

I feel a massive part of the problem now is that governments have taken on the burden of spending, which will rarely promote confidence. Directly because investors will tend to be wary of weak governments fiances, loose fiscal policy and the tax rises that will be needed to pay for it (let’s face it, most western governments at the moment are broke, on their way to being broke or are kicking the can down the road and simply ignoring their fiscal problems) and indirectly because of the 2nd round effects – the very fact that governments are trying so desperately to act suggests weak economies going forward, which deters invetment.

I know you are a Keynesian, but the cause of this whole crisis was too much debt/too much credit extension. The bubble burst and deleveraging is the natural (albeit painful) reaction to this. By not letting this happen naturally, all I feel (and there is plenty of evidence for this) is being achieved is that the crisis is being prolonged rather than solved. Confidence will only return when asset prices are allowed to fall to fair value.

6: “I know you are a Keynesian, but the cause of this whole crisis was too much debt/too much credit extension.”

You forget to mention the effective role of the generous staff bonuses paid by the banks in the boom years to incentivise the extension of credit.

You also overlooked to mention those other factors which brought the collapse of the pyramid: the quality of the bank loans and the creation of opaque financial instruments, which is why inter-bank lending dried up in 2007/08 when the banks ceased to trust the collateral of borrowing banks.

The drying up of inter-bank lending was disastrous for banks which had been relying on that source to finance their rapidly growing portfolios of sub-prime mortgages – better than 100 per cent loan-to-value mortgages became a talking point before the crash.

Warren Buffett warned us back in 2003 about the increasing opacity of financial instruments being traded as well as the potential consequences but few took any notice:

“The rapidly growing trade in derivatives poses a ‘mega-catastrophic risk’ for the economy and most shares are still ‘too expensive’, legendary investor Warren Buffett has warned.”

The banks have much to answer for besides the attempts to rig Libor and the re-writing of history on a grand scale.

8. gastro george

While I agree with the main observation of the OP, I can’t really see that there is much of a supply-side problem with bank credit. As has been noted, deleverage is natural in a recession, and major companies are sitting on oceans of cash because there are no worthwhile investment opportunities. Presumably banks are doing much the same.

What is missing from the equation (as always) is demand. Increase demand, and investment will follow.

To this extent, a specialised investment bank is a Good Thing, but could also just be a supply-side measure. We also need state investment in new infrastructure, and a reversal of austerity, to trigger demand.

@7 Bob B

Derivatives and other such instruments only really played the part of a catalyst to the underlying reaction. CDOs, MBS etc played a role but it was the underlying mortgages which caused the real problems in banking. CDOs were almost exclusively on US home loans – not European ones – so really have little or no part to play in the problems in the massively pumped up property markets in Spain, Ireland etc, and nor did they have anything to do with the fact that many European governments are massively over-indebted. At best you could say they opened people’s eyes to the fact that AAA might not be as safe as people think and forced people to re-evaluate credit risk.

Nor indeed did investment banks cause the main problems. Lehmans went down and there were losses in them, but for the most part it was big, high street retail banks which had the biggest write-downs and needed the bailouts. The main causes of this were their massive home loan books, all fuelled by easy credit and a speculative property bubble.

If you want to blame anyone, you should start with Alan Greenspan’s low interest rate policies, Bill Clinton’s CRA act and paul Krugman egging them on the whole time.

I quote Krugman in the NYT in 2002:

“To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

Though he now claims what he said is not what he meant – the defence of economists who got it horribly wrong everywhere.

As for derivatives – they are only dangerous for those who don’t understand them. In the public’s eyes they seem to mired in some form of devil-banker born complexity. In reality, most derivatives are very simple, and often carry less risk than the underlying asset they replicate – notably bonds, where you can lose everything in a default. Some indeed are extremely comlpex, but the vast bulk traded are extemely simple, to the point that many are becoming exchange traded.

You do also realise that every time you purchase insurance, or get a home loan, you are essentially buying a derivative, don’t you? In insurance, the underlying “asset” is an actuarial definition of risk. The insurance company repackages that acutarial payout into a strip of cash payments – your insurance premium. Your home loan is a derivative transforming the maturity of the borrowing at the bank from short to long term secured against the asset, the interest rate risk being hedged by an interest rate swap – a derivative.

For the most part I doubt most people really understand what a derivative is, short of bandying about 3 letter acronyms and cursing them as the work of the devil.

@8 Gastroo

part of what I was trying to get at is that I think that it will be very hard for demand to recover whilst there is so much uncertainty regarding government, bank and individual balance sheets. The US was much more forthright in dealing with their housing sector problems, albeit in an uncompromising way by forclosing on large maounts of homeowners. House prices crashd, but at least that market has found a price level where people are now willing to invest again because all the pain has been taken and the damage to balance sheets is out in the open. The US is growing significantly better than Europe, and I believe in part it is due to this “creative destruction”.

In Europe this simply hasn’t happened. Spain for example hasn’t dealt at all with it’s property issues. This has paralysed banks, investors and individuals, who are trapped like zombies in a debt laden limbo. No-one truly knows what the scale of losses are, so until that is finally acknowledged it is very difficult to move on from it.

Surely the graph just shows the root of the problem, that during the bubble the banks were lending irrationally and that the crash means they are now taking a more rational line.

” Third, FLS is something of a scatter approach to supporting lending – not targetted at where credit is especially constrained: ”

All these schemes they come up with are just a headline chasing gimmicks. The FLS, GIB, ECTR and now the Cable bank. There is almost a new one announced every week and they never amount to as much as the hype. Everything we have learned about this coalition is they have an infinite capacity to cause policy paralysis by constantly sending out mixed and often contradictory signals. The ECTR that was going to provide BoE cheap funding for banks because they were apparently liquidity constrained was not even that cheap and was not required. At the last auction a few weeks ago the banks only took £150 million of the £5 billion on offer.

Instead of trying to micromanage the banks lending books they could just reduce the stupid procyclical capital requirements and achieve the same thing as most of the schemes. The type of capital requirements countercyclical policies that they should have been doing in 2005/06, they are now doing when they should now be going the opposite way and relaxing capital requirements. It just creates an omnishambles atmosphere of sending mixed messages when they are forcing banks to hold more capital and government ministers on the 6 O’Clock news yelping with a straight face we want the banks to lend more.

I don’t find your chart very meaningful at all. The problem with the chart is it is too aggregated. One really needs lending charts more disaggregated to draw meaningful conclusions. For example, how much of the decline in UK lending is caused by the large chunk taken out of UK lending by the retreat of the Icelandic and Irish banks from the UK? It is comforting for some to just bash the UK banks for failing to fulfill their role and ignore that a great many lenders who used to lend in the UK are just no longer here. How much of the decline in lending is due to the bursting of the UK commercial real estate bubble? That market really was a bubble and we should expect to see a lower level of lending to CRE. Lehman Bros. who obviously no longer exist were the source of around 15% of corporate funding in the UK, particularly in CRE. Aggregate charts like gross debt do not tell us a whole lot. Yet people read so much into them.

The charts and comments in this speech by Ben Broadbent are much more meaningful in understanding where we are and what are the problems with the banks.

The paper is good for exposing the myths behind the simplistic stories that the UK media class have fed to the UK public. We had a huge credit boom in the UK, the evil banks were profligate and now we are all suffering the consequences. It is a nice comforting moral tale, the only problem is it never happened. I should clarify, it never happened here. The losses that the UK banks suffered and have screwed up their balance sheets were in Johnny Foreigner land. The mortgage losses on their non-UK mortgages are 15 times their losses in the UK. Around 75% of their total losses were on non-UK loans.

The real credit boom in the UK was funding for commercial real estate and that distorts gross debt and figures for the decline in new lending. When we lump in households with corporates as collectively the private sector we get a distorted picture. See chart 13 on page 10.

There was some increases in the levels of unsecured credit but with the secular declines in real interest rates that is unremarkable. Television programme anecdotes about people with 13 credit cards are just tripe as can be seen from the low level of losses. Most of the increase in UK debts are related to mortgages for expensive homes. There is no doubt that UK housing is expensive and excludes young people from entering the market. For that state of affairs we can blame our old friends the simply awful baby boomers. They refused to allow the building of new homes at a time of rising population and increasing households in order to transfer financial resources from the young to themselves i.e. their own children.

The notorious story about the 125% Northern Rock probably only concerned a few thousand borrowers in a population of 63 million. The vast majority of mortgage lending was not profligate and the loans are performing as can be seen from the low level of losses and repossessions. Yes, interest rates are on the floor but they are on the floor everywhere else as well. Therefore, the increase in debt is more related to expensive housing than a genuine credit bubble.

There are genuine problems in the mortgage market for first time buyers accessing finance without big deposits. However, I am unconvinced that UK business is genuinely starved of finance. They might not like the cost of credit but that is different from saying they can’t get it. The BBC featured a guy on the news the other night complaining he could not get finance to expand his business without offering his house as collateral. He appeared to think that was an outrageous imposition. He thinks his business expansion plans are such a good bet he wants a bank to back him with their funds. Yet, not that good a bet to pledge his house as collateral.

Tyler: “As for derivatives – they are only dangerous for those who don’t understand them.”

Thank’s for that ‘brilliant’ insight. Judging by the quote @7, it would seem that Warren Buffett, the legendary investor in stock and one of the richest people in the world as a result of a hugely successful investment portfolio, is among those who didn’t understand derivatives – not least for the illuminating reason that CDOs based on mortgages were thoroughly opaque.

“Lehmans went down and there were losses in them, but for the most part it was big, high street retail banks which had the biggest write-downs and needed the bailouts”

In Britain, Northern Rock went down because it was dependent on inter-bank borrowing so when that dried up after banks ceased to trust the collateral of borrowing banks, Northern Rock became insolvent. RBS went down because of its ill-judged takeover of ABN AMRO, “also in March 2009, RBS revealed that its traders had been involved in the purchase and sale of sub-prime securities under the supervision of Fred Goodwin” [Wikipedia]. Lloyds TSB required bailing out after its ill-judged take over of HBOS.

The history of what went wrong in banking shows up the monumental incompetence of bankers. In today’s news: PPI mis-selling complaints to FSA soar:

The number of complaints to the FSA about British banks and insurance companies soared 59pc in the first half of the year, largely driven by an increase in mis-selling claims over payment protection insurance (PPI).

By accounts in the news, the high-street banks are now in the process of paying out £10 billions in compensation for mis-selling Payment Protection Insurance.

Where I fall out with fraternal Marxists is that the failure of the banks wasn’t to the benefit of their shareholders but to the benefit of staff bonuses which fuelled trading that caused the banks to fail.

After all that, the bottom line is that we shouldn’t take seriously anything that bankers say.

@ Bob B

I’m guessing from your answer that you fall into the “3 letter acronym” catagory, and really don’t know what derivatives are.

Some derivatives like CDOs are indeed opaque – mostly when the underlying assets themselves are opaque. Some derivatives are extremely simple – bond, equity futures, interest rates swaps etc. The vast bulk of derivatives traded are the simple type.

As for Buffet, for all his guru status, Berkshire Hathaways returns have been less than stellar for a long time. Indeed, it is massively (0.8) correlated to the Dow Jones, and doesn’t outperform it. He’s basically just a very large index tracking fund. Nothing particularly special about that.

A lot of banks took losses on CDOs. None of them went bankrupt because of them. What did happen though, as you say, is that the interbank market dried up completely, meaning banks couldn’t fund themselves. Not a problem with derivatives.

PPI etc is not investment banking – it’s retail banking.

If you look at the returns to shareholders in banks leading up to the crisis, they were actually very good…..

Bottom line, is we shouldn’t really take anything you say seriously when it comes to banks and finance, because you clearly don’t know how these things work.

Tyler: “I’m guessing from your answer that you fall into the ‘3 letter acronym’ catagory, and really don’t know what derivatives are. ”

Well, I’m a firm believer in evidence-based policy.

Evidently lots of bankers didn’t know about derivatives or they wouldn’t have have made the multi-million losses on derivatives trading that they did. And Warren Buffett sure wasn’t clear or he wouldn’t have gone to press in 2003 warning that derivatives were opaque and could prove to be a catastrophic risk to the financial system – see the citation with link @7.

The fact is that inter-bank lending dried up in 2007/08 because bankers didn’t trust the collateral of borrowing banks and that is a sure enough sign that bankers were not disposed to trust the financial instruments of other bankers. If bankers don’t trust other bankers, why should the rest of us trust bankers?

The fact is that bankers have been ripping off both their customers and their shareholders:

“The world’s big international banks are paying out much more on staff costs relative to profits since the financial crisis while slashing the portion of income paid out in dividends, according to data compiled by the Financial Times. . .”

@ Bob B

Well done for not managing to grasp anything of what I have said. Understanding something, for example a derivative, does not mean you are gauranteed to make money on it.

If you are so keen on evidence, look where the massive losses occured in the financial crisis. You’ll see that the main losses in the financial crisis since 2008 have not been in derivatives. They have been in the underlying assets – mortgages and government bonds.

You are right (shocker) in saying that the money markets dried up because banks didn’t trust each other’s credit in 08. However, if you knew anything about th emoney markets, you would realise that that the retail banks massively dominate that sphere. Not investment banks. And it was retail banks with massive mortgage books which took the bulk of the losses.

As for bank share dividends, they didn’t go down. They actualy went up. However, as a % of profits they went down. Why? Because the tax regime encourages companies to pay out as much money as possible to reduce their tax bills, and the easiset way to do that is via costs, which is mostly staffing. It’s not just a feature of banks – any industry where human resource costs are the main drawdown on the business has the same issues. Check out google or facebook for example.

Tyler: “Understanding something, for example a derivative, does not mean you are gauranteed to make money on it. ”

The issue is – as Warren Buffett observed in 2003 – whether derivates are sufficiently transparent for rational investment decisions or whether the derivatives or their underpinning assets or links to financial market prices are too opaque. Try this news report from a few months back:

Some of Britain’s biggest banks are facing a hefty compensation bill today after the City watchdog said it found “serious failings” in the sale of complex financial products to small businesses.

Barclays, HSBC, Lloyds and Royal Bank of Scotland have agreed to compensate customers where the mis-selling of so-called interest rate swap arrangements (IRSAs) has occurred, the Financial Services Authority (FSA) said.

IRSAs are complicated derivatives products that may have been sold as protection – or to act as a hedge – against a rise in interest rates without the customer fully grasping the downside risks.

These derivatives were sold supposedly to protect small businesses borrowing money from banks against the contingency of rising interest rates. In fact, interest rates went down and the borrowers had to pay more for that.

The generous interpretation is that the banks who sold that protection to business borrowers didn’t understand how the derivative worked. The alternative interpretation is that the banks were intent on fraud.

Now try this from Friday’s FT:

“A large section of the [Libor] reform aims to make it easier to catch and punish attempts at manipulation, targeting the problem of traders who sought to push rates up or down in order to make money on derivatives.”

@ Bob B

An IRS is a very simply product. Very simple. It simply turns a floating rate into a fixed one – in your example it would simply turn a floating rate loan into a fixed rate one. I guess you don’t realise that if you take out a fixed loan and interest rates fall you are losing money. If you take out a floating rate loan you will be making money, but if you hedge it (turn it into fixed with an IRS) you will lose money on the IRS but the same amount, such that the two products have the same value.

My guess is that a lot of people, like you, clearly don’t understand that there is a risk free rate, and fixing your loan rates is NOT risk free. If you do so, and rates go down, you are losing money. If they go up, you make money (by paying a lower interest rate). On the back of that I’m sure a lot of people complaining are doing so because they are losing money on the IRS, seperating it from the loan it is attached to, even though the total cost of the structure remains identical to a fixed rate loan.

I think the problem in your above example comes from people not understanding what they are doing, and sometimes from experience, willfully misrepresenting their understanding of the product where they think they can bend the bank’s arm with threat of action justified or not to get out of their poor trade. I’d also hazard a guess that if rates had gone up sigificantly you wouldn’t see anyone complaining about these trades. After all, they are basically jsut fixed rate loans.

I’m sure there are cases of true mis-selling, but the regulation for these products is incredibly tight already, and I expect the vast bulk of these complaints will never go any further – not least because it fixed the loan repayments, which decreases the liability for small borrowers in balance sheet terms (in exactly the same way most people prefer to have fixed mortgages to make it easier to know what they have to pay back every month).

Really not complicated at all, and IRS trade in the markets thousands of times a day – so 28,000 trades in over 10 years is a *tiny* numbers.

So Milton Friedman has nothing to do with the crisis? Keynes’s most famous student Galbraith on Milton Friedman. The worst thing for Milton is that his ideas have even been attempted.

Milton Friedman clearly states if the money supply never shrinks you never have a recession or a great depression. Defending all these financial products which were always going to turn sour as many Keynesians always said they would. Krugman is a moneterist or NeoKeynesian. Galbraith again Krugman is the biggest disappointment to the economics profession.

Monetary Growth is not Gross Domestic Product being sold by the media. Remember only the mail opposed Hitler in the 1930’s.

The new statesman has finally some great articles on the subject. Milton Friedman’s myth of the Great Depression is one big FRAUD.

Increasing the money supply by 3% every year caused the crisis why do the banks have so much money in the first place? Why is bank lending a leading predictor of a countries well being?

Hayek’s all government led’s to serfdom being sold by Millhouse Capital or Roman Abramovich and his Ayn Rand morals of unregulated capitalism is a joke.

Are corporations, sovereign states and pension funds going to live off bond sales for all of eternity?

The system has run its course and needs new direction. And England needs to reaffirm it’s relationship within the Commonwealth instead of allowing overseas firms to destroy Canada, Australia and New Zealand.

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