Liam Halligan: UK and Europe banks languish in a 'zombie' bank malaise

In a must read Telegraph column, Liam Halligan lays out how policymakers are kicking the can down the road with unaffordable policies instead of addressing the bank insolvency that underlies the current global economic malaise.

Presented without comment.

British banks are sitting on “£40bn of undeclared losses”. So says Pirc, the UK’s leading shareholder advisory group. What’s more, Pirc argues, the massive backlog of undisclosed bad debts is preventing our banking sector from making vital, growth-boosting loans to creditworthy businesses and households. 

It doesn’t surprise me that some of the UK’s leading banks are technically insolvent. What does surprise me is that it’s taken until last week for a respected professional body such as Pirc to state the obvious.

It’s not that I don’t congratulate Pirc for what it has just said. A relatively small organisation, after all, is now openly defying what is probably the UK’s most powerful lobby. Yet Pirc, and others, should still have called the Western world’s banks on their vast, undeclared losses a very long time ago. Some of us have been banging on, for years, about banking black holes blocking an economic resurgence — ever since this ghastly crisis began, in fact, in mid-2007. 

The biggest financial problem the West needs to solve isn’t low growth, or unemployment. Economic torpor, and the human tragedy of joblessness, are symptoms, not causes. The issue isn’t, as some would have it, that governments are “cutting spending too far and too fast”. Western governments are barely cutting, if at all. 

The most significant financial problem we face, in the UK and Europe, is that our banking systems remain gridlocked, with banks doing everything possible to conceal tens of billions of sterling and euro losses.

All those non-performing loans, and toxic debts, many of them property-related, haven’t gone away. We don’t know their precise scale because the banks still won’t publish full sets of accounts, including their “off balance sheet vehicles”. And, disgracefully, governments and regulators have been too scared to force them.

A lack of knowledge about each others’ solvency makes banks reluctant to lend to each other. Investors, too, fret about recapitalising banks, or holding bank shares, as they don’t know what they’re buying. So interbank lending — the wholesale market for loans — remains extremely sluggish, causing a finance drought among solvent households and firms. 

Investment then suffers, housing markets suffer and economic life stagnates. With the credit channel “blocked”, the wheels of Western finance have stopped turning, resulting in economic stasis. 

Forget “too far and too fast”. Forget “growth versus austerity” and all the other compartmentalised, tribal policy debates we hear being hashed-out on the airwaves. West European growth is so slow, with some countries re-entering recession, because insolvent banks, pretending they’re still viable, are hoarding cash in a desperate and cynical bid to survive when, by rights, they should crash and burn.

Legitimate demands for credit, not least from firms wanting to maintain or expand their operations, are then denied or granted only at ridiculous rates.

The West isn’t recovering and unemployment is rising — and the heart of the problem is a group of opaque, moribund banks. This has long been obvious, to those with an open mind and even a modicum of economic expertise.

Attempts to keep zombie banks alive, extending the existence of commercially “dead” institutions, have seriously damaged state balance sheets. Some of the world’s “leading economies” are now keeping their debt markets afloat only by ordering central banks to issue electronic credits, then using them to buy sovereign paper. 

For several decades, Western governments have borrowed and spent irresponsibly. Trying to clean up after the banks, though, has pushed otherwise still solvent nations to the brink of bankruptcy and beyond. And in western Europe, of course, this evil brew had been made even more ghastly by the policy incoherence, and conflicting incentives, imposed by the economic madness that is the euro. 

Until now, the Western world’s response to “subprime” — a bank insolvency-led crisis — has been to follow the “Japanese model”. This amounts to covering up for the banks, allowing them to pretend they have assets they don’t, and don’t have losses they do, and then “praying for a miracle” that capital levels are somehow restored. 

History shows this model doesn’t work. It was only in 2010 that Japan’s GDP recovered to its 1991 pre-bust level.

The only way to smash this banking sector deadlock is by imposing the kind of “full disclosure” bank transparency that FDR’s administration employed to break America’s Great Depression in the mid-1930s, or that Sweden used to escape its early-1990s banking mess. 

This involves forcing banks to recognise all their excess liabilities, pushing those beyond repair into administration, then supporting those worth saving so they can rebuild their capital levels — in large part from retained earnings and other forms of private finance. 

Needless to say, Western banks don’t like the idea of “full disclosure”. 

Under the Swedish model, a lot less money is available for bonus and executive pay. “Full disclosure” also makes banks face up to the implications of their deeply misguided previous investments, with some of them going bust. “Full disclosure”, moreover, could well expose some pretty serious financial fraud. 

That’s why, ever since this crisis began, the ultra-transparency that’s needed — so markets can trade efficiently and the banking system can start oiling the wheels of the economy again, rather than seizing them up — has been the “third rail” of Western politics. 

The banks whisper Armageddon will occur if they’re required to recognise their losses. While this might be true of executive remuneration, and the reputation of certain City grandees, it’s not true for the economy as a whole.

Fundamentally sound banks can still operate and extend loans even when they have negative book capital. But they need to retain earnings, and end bonuses and dividends, during the period their capital is rebuilt. 

So far, the raw power of the banking lobby, its attack-dog PR tactics and political donations, have kept demands for “full disclosure” at bay. Those of us who’ve made such calls have been consigned to the outer fringes of polite society...

Pirc analysed the 2011 accounts of the UK’s top five banks, then calculated expected debt write-offs in the coming years that aren’t yet set against profits. The banks retort that their accounts adhere to IFRS accounting regulations. 

Such regulations, though, introduced in 2005 after a ferocious bank-led lobbying, are a major part of the problem. As Pirc says, IFRS accounting allows the banks to “mask the true position” by “including fictional assets and fictional profits”. As such, salaries and bonuses are then paid out on inflated numbers, when such earnings should actually be used to bolster capital. 

By entering the fray, Pirc has made it respectable to talk about “full disclosure”. Other institutions will now hopefully acknowledge what is obvious and point the finger at our busted banks. Given the unhealthy closeness of the relationship between Western Europe’s politicians and “high finance”, I don’t expect such courage to be shown by our elected officials. So it falls to professional bodies, campaign groups, independent commentators and broader society to bang the drum. 

The “full disclosure” debate has been rolling in the US, American banks having recognised their losses to a far greater extent than we’ve seen in Western Europe. That’s why the US recovery, while still uneven, has been far stronger. 

Europe, meanwhile, the UK included, continues to languish in a “zombie bank” malaise, buying time with QE, summits, and endless can-kicking measures. How much longer can our leaders dodge the really tough decisions? As long as we keep letting them, I say.