A bank solvency led financial crisis is becoming a crisis of confidence

In his Guardian column, John McFall describes how a bank solvency led financial crisis is in the process of becoming a crisis of confidence in the UK.

Why this latest panic move by the government? Depressingly, the UK shares with Italy, alone among the Eurozone countries, the distinction of being in recession. With no growth prospects, banks and businesses holding on to their cash, and a million young people out of work, education or training, the government has had to ditch its Plan A for austerity.... 

So now, with certainty in society and the economy waning, the government has drawn up a hasty and incomplete Plan C for confidence. It is centred on one idea: that by unshackling the banks, they will surge forward with new lending, spurring the economy on to growth.... 

the Bank of England will provide a discreet new credit facility, permitting the banks to withdraw up to £5bn a month on the basis of lower-quality assets than were previously accepted. In addition, a new "funding for lending" scheme will provide an unspecified level of cash for banks to lend to their customers (a vague target of £80bn has been mentioned). 

So the focus of the authorities has clearly shifted from the long-term stability of the system to the need to grant the banks immediate room to begin lending. But will this latest strategy work? 

Have the banks been holding on to their cash and refusing to lend? Or have businesses and others so little confidence in the future of the economy that they are unwilling to borrow any money? 

Hector Sants, the departing chief executive of the Financial Services Authority, has said that banks are hoarding cash rather than lending it, such is their lack of confidence in the economy. 

The banks retort that there is little demand for more credit from households or businesses, again as a result of their lack of confidence. ... No doubt the banks will be grateful to the Bank of England for the extra wriggle-room they have been given, but there will likely be no increase in lending unless confidence can be improved.

Why is there no confidence?  Because policymakers and financial regulators continue to pursue policies designed to prop up bank book capital levels at all costs.

If the financial condition of the banks is what the regulators claim, then why not require the banks to provide ultra transparency and disclose their current asset, liability and off-balance sheet exposure details and let market participants independently confirm this fact.

This would restore confidence overnight as market participants trust their independent analysis.

By letting the banks continue to provide disclosure that results in them resembling in the words of the Bank of England's Andrew Haldane 'black boxes', the regulators are sending the strong message that the banks have something to hide.

It is reasonable for market participants to think the banks have something to hide since regulatory forbearance was adopted at the start of the financial crisis.  Under regulatory forbearance, banks are free to pursue 'extend and pretend' to keep zombie borrowers alive.

As a result, it is easier for a zombie borrower to access additional credit than it is for a creditworthy borrower to get a new loan.

Ironically, the cheap funds from the Bank of England could go to the zombie borrowers.

It is this sort of policy outcome that undermines confidence.