Britain is locked in a sterile argument concerning the lack of credit on offer to companies. The Bank of England argues that weak banks do not lend, so they need more capital. The industry counters that tighter regulation kills risk-taking and lending. But both sides agree that shovelling money out of the banks’ doors is important for economic recovery. Sad to say, neither of the positions, nor the inferred causal link between lending and recovery, is necessarily correct.
The BoE has been unwavering in its insistence that weak lending results from banks having too little capital – the money reserved to ensure they can absorb losses. The minutes of the most recent Financial Policy Committee meeting note: “It was striking that better-capitalised UK banks had been expanding lending to the real economy since mid-2012 while other institutions had been contracting lending”.
In the long run, the central bank’s position is correct. Capital is not money locked away that cannot be lent to profitable ventures. It gives the institution the ability to withstand losses without recourse to other parties, including bondholders, depositors and taxpayers. So lower capital buffers make a bank more risky and will frighten some depositors and investors into demanding higher returns, restricting the funds available to lend.