Bringing Bank of Scotland home not as simple as it may sound

IN CALLING for the Bank of Scotland to be “brought home” as part of a break-up of Britain’s giant banks, Liberal Democrat shadow chancellor Vince Cable will have pleased his audience at the Reform Scotland dinner in Edinburgh last night. The Scotsman vigorously questioned the Lloyds takeover of HBOS on competition grounds at the time and many would like to see a phoenix Bank of Scotland arise from the ashes of the old.

However, as the problems of the banking sector have deepened and lending to the non-financial business sector has contracted, a dismantling and restructuring of the banking sector is but one of the more far-reaching and widespread reforms required. This must have as its centrepiece an economic recovery that will boost business confidence and rekindle business demand for capital to finance expansion. Demerger and sell-off, desirable though they are, will not of itself bring this about. And there are serious problems to be addressed before a “born again” separate Bank of Scotland can successfully re-enter the field .

Many small businesses have suffered in this recession because of a marked tightening in loan terms and conditions, while loan restructuring fees charged by banks have bordered on the rapacious. Within the state-supported banks themselves there has been a clear conflict of priorities between the demands for balance sheet and capital strengthening and the maintaining and expanding of loans to business, particularly to small firms.

However, the figures on bank lending to business reflect not only constrained supply but also a reluctance among many firms to increase overdrafts and loans at this time, reflecting a lack of confidence in domestic demand and the economy more generally. As a priority, business confidence has to be encouraged by measures such as tax incentives to kick-start the next business cycle.

Greater competition through encouraging divestment and new entrants into the banking market would certainly help. But here a reborn Bank of Scotland would face two problems. The first is how to overcome legacy issues after an imprudent lending spree that has ended with some 23 billion of problem loans, many of them property-related, having to be written off. This deeply flawed lending was perhaps paradoxically the work of a “narrow bank” whose judgment and culture nevertheless proved to be deeply flawed.

Mr Cable’s remedy is too simple if it is reliant on structural change alone. It may be some years before all of the toxic loan book is discharged and in the meantime the bank will continue to need parent group support. A further challenge will be how to overcome the brand contamination and establish a new competence in which depositors and investors can have trust.

That is a massive challenge that will require both a wider recovery programme and the training of a new generation of bankers as well as structural reform. For the present the stricken state-run banks have to discharge their obligations to taxpayers and get themselves fit for purpose.