Article by Michael Baxter 18 June 2012

©2012 Investment and Business News. 

The Bank of England bravely turned its tail and fled. By the standards of the UK’s central bank the plan that was unveiled last week was revolutionary. By the standards of what the UK economy needs, it was totally inadequate.

Credit where it is due, George Osborne was in fine form when he made his recent Mansion House speech. Full of jokes, and witticisms: they say laughter is the best medicine, and if that was true, Mr Osborne revealed a cure to the UK’s ills last week. But then if that was really true, the cabinet should resign and make way for Michael McIntyre, Eddie Izzard and the rest of the gang. Greece could say to the rest of the Europe: “tatty bye everybody.”

But in fact the UK chancellor and Mervyn King, Governor of the Bank of England, fell short – a long way short – of what is required. Alas the duo showed themselves unaware of the seriousness of today’s crisis, and indeed its causes.

Actually, the plan they unveiled has two components: a ‘funding for lending facility’ and an ‘Extended Collateral Term Repo Facility’. The former involves providing lending to banks in exchange for certain assets as collateral, but the condition of this funding is that the money is used to lend to businesses or households.

The former involves the provision of up to £5 billion a month in loans to banks in exchange for security of virtually any asset banks choose. The objective of this measure is clear. The Bank of England fears that British banks are set to face new headwinds, especially if Greece exits the euro. So the plan is to try to ensure British banks have sufficient buttresses to withstand the chaos they may be experiencing.

You could argue that one of the two schemes is a form of bolstering defence. To put it in football terms, packing the midfield with holding players. The other scheme is more attacking in nature; the equivalent of bringing on Theo Walcott as a substitute. And, of course, attention has focused on the plan to get banks lending again. The Bank of England says that it could entail up to £80 billion in new lending.

Some critics immediately leapt on to their high horses, and slated the scheme. Professor Philip Booth of Cass Business School said: “The government has got itself into a terrible muddle over this crucial policy area. On the one hand it is imposing huge liquidity and capital requirements on banks to reduce the potential cost to the taxpayer of bank failure… On the other hand, the government is bringing in a series of schemes to subsidise and guarantee lending through the same commercial banks whose lending is being restricted.” He added: “The left hand of the Treasury does not seem to know what the right hand is doing.”

But in this regard, the critics may not be right. For George Osborne also revealed a change to the objectives of the Financial Policy Committee. Up to now this has had one task and one task alone: financial stability. Well, now it has a second role: supporting economic growth. This may mean that banks will be allowed to relax their drive to improve their capital to lending ratios. So actually, contrary to the views of the Cass Business School, it does seem as though all feet are pretty much kicking in the right direction.

Now, the critics are right to criticise, but they somewhat miss the point. A hint to the problem relates to that word ‘could’. To repeat, “the Bank of England says that it could entail up to £80 billion in new lending.” In reality, the new scheme will almost certainly not provide that much new lending. But even if it did, it’s the wrong plan.

The problem relating to banks lies much deeper than either Mervyn King or George Osborne seems to realise. The UK needs something far more drastic. In short it needs to see billions of pounds flooding into a new type of venture capital. Sir Mervyn did refer briefly to such an idea, but dismissed it out of hand as being too risky. And that is why he bravely turned his head and fled, because he is wrong about the risk. The truth is that timidity from banks and policy makers is the biggest hurdle facing the UK economy. In its original incarnation, the company we call 3i was known as the Industrial and Commercial Finance Corporation and was backed by the Bank of England and British banks. Nothing short of a latter day equivalent of that will do. And to find out why, read the next piece…

©2012 Investment and Business News. You are free to re-publish this article, providing you refer to investment and business news as the original source, say something suitably gushing about this newsletter, and invite readers to sign-up at http://www.investmentandbusinessnews.co.uk/