Michael Gove - Beleaguered banks need a break, not a beating

Published on Saturday 6 December 2008 18:41

WELL it didn't help Neville Chamberlain survive. The last time we slashed interest rates to 2% the country was at war. And the Prime Minister went six months later. The current rate cut comes at an equally crucial time for Gordon Brown. Which is why he declared hostilities against his principal enemies so quickly on Friday morning.

The Axis powers Brown has in his sights are the banks, which are, so far, reluctant to pass on that rate cut in full. The Prime Minister needs them to surrender if he's to have any chance of victory. The country needs them to surrender if we're to maximise the economy's chances of survival. But there's no sign the white flags are being hoisted above the nation's counting houses. It could be a long and bloody fight. And someone else might well be in No 10 when the time comes to hang out the bunting.

The single greatest problem in the economy at the moment is the lack of credit. Money isn't flowing to the individuals and businesses who need it. Which is why the pressure is on the banks to start lending, and to cut the cost of their loans.

But Britain's banks are in a hyper-cautious state. They were encouraged to join in the great loose-money party of the last decade. And the more intoxicated they became by the temptations on offer, the less control they exercised. But when the final champagne cork had been popped, and the reckoning came, they found themselves more than just hungover. They were so weakened by excess they were fighting for their lives and praying just to survive.

The need to keep the banking sector alive, and to ensure it could do its job of providing credit to the country, led all the major political parties to back the idea of bank bail-outs. But while the banks have survived, their confidence has not. The Bank of Scotland headquarters on The Mound, where many of the country's banking elite held court, were once among the commanding heights of the British economy. Takeovers were plotted, rivals swallowed, loans offered and credit extended in a breathtakingly assured advance. But now, with hindsight, that journey looks increasingly like a Rake's progress. It was magnificent while it lasted but now the pain has to be endured and the bills have to be paid.

The banking sector has lost more than just confidence. The balance sheets of many of our banks have suffered massive losses as the value of assets, like my home, which looked to be heading remorselessly upwards, has had to be savagely corrected. In these new and difficult times, the banks themselves need credit. And while the rate of interest the Bank of England sets has fallen, the rate at which banks lend to each other, known as Libor, remains significantly higher. To add to the pain, the money the Government has given the banks comes at a high price because of the preference share structure ministers have imposed. So banks face having to pay a significant sum for their own money, and at the same time they also see their own balance sheets weakening further every day as their clients fall into arrears or, in some cases, collapse altogether.

Every firm that closes, every job that is lost, every mortgage payment deferred is a tragedy in itself and contributes to exacerbating the pain for everyone as the banks see more of their existing loans imperilled. And that's not the only problem. While we are desperate to see the money flow, the Bank of England is telling banks they must build up their stocks of capital to a more prudent long-term level. So while the Chancellor says banks have to pass on the cash he's given them, the Governor of the Bank of England is telling them to hold on to it.

I believe the banks have to get the cash flowing otherwise the real economy will only suffer further, and the companies that go under will take the banks' balance sheets with them anyway. Inaction is not an option. But I fear the Government's current plan – which appears to be threatening to lock bank executives in a room with Peter Mandelson until they cry for mercy – is far from ideal. As Mandelson's fore-runner in the field of gentle persuasion, Torquemada, knew only too well, the problem with forced conversions to the path of virtue is that they seldom last. And as Torquemada also knew, there's a limit to how much more pain any of us can stand before we give up the ghost.

What we need instead are Government measures that support virtue rather than compelling it. The ideal way to get the banks lending is for the Government to guarantee their loans with an insurance scheme. The Treasury has the wherewithal to promise to underwrite those loans that go bad, and the very fact that it will stand behind bank lending will mean the risk of default is reduced.

A Government insurance scheme is state intervention in the markets, I accept. But there always has been a role for states in getting markets to work. It is a myth that Conservatives don't believe in a role for the state, and think that when bad times loom the only appropriate posture for Government is a set of crossed fingers. The man who rescued this country in 1940 was a Tory to his bootstraps, but on his watch we mobilised the power of Government more powerfully than ever before. The question of the hour is not should we act, but rather how. Does Government help us prosper by supporting or compelling, enabling or directing? Brown needs to realise that the real credit for any recovery will come from a banking sector that has recovered its confidence, not one that has been beaten into submission.

Michael Gove is shadow secretary of state for children