Leader: Case for central bank assistance grows

Published on Friday 1 October 2010 15:35

Warnings from the New Economics Foundation of a second credit crunch for the UK banking sector may be over-stating the risks that lie ahead. But it is a sober reminder that the UK banks face big challenges in finding new capital on which to draw to replace the massive taxpayer support they have enjoyed.

Credit conditions in wholesale money markets have eased over the past 18 months and bank capital ratios have improved. The major problem is that the banks have been asked to address two conflicting objectives at once: improve their balance sheets to meet the new Basel 111 capital requirements, and to step up lending to business and in particular the small and medium sized enterprise sector. The banks retort that SME demand for loans has been subdued. But that may in part reflect a reluctance to apply, given the widespread reports of loan rejections and the application of sharply higher fees and charges.

There is growing pressure on the Bank of England to embark on a second round of 'Quantitative Easing' (QE2). This would help give the banks extra liquidity for on-lending. As some 200 billion of 'QE1' made little impact in this area - the bulk of the money going on capital strengthening - an alternative approach would be to use QE2 to finance tax cuts for the business sector. The NEF report makes amply clear the long tail effect of the worst banking crisis in 80 years. As the pace of recovery appears to be softening, the case for supportive action from the central bank becomes ever stronger.