Thursday, November 29, 2012

Bank of England finally gets tough and says banks need to come clean about their exposures

It appears that the Bank of England has finally decided that pursuit of the Japanese Model for handling a bank solvency led financial crisis results in a Japan-style economic slump.  Since they do not want this horrible fate to befall the UK, they are adopting the Swedish Model and requiring the banks to recognize their losses upfront on the excess debt in the financial system.

The Bank of England is achieving this by saying that the banks need to come clean about their losses regardless of the accounting treatment.

Regular readers know that this is what your humble blogger has been calling for since the beginning of the financial crisis.

As described by Larry Elliott in his Guardian column which also applies to the EU and US,

The fear that haunts the Bank of England is that Britain could become the next Japan. Permeating the whole of Threadneedle Street's latest update on the state of the financial sector is the conviction that, as with Japan in the 1990s, the sickness of the banking sector could throttle the life out of the economy. 
With Britain already half way through its own lost decade, the Bank's financial policy committee believes immediate action is needed that will force lenders to improve their financial resilience. 
If the warning sounds far-fetched, then compare and contrast. Britain had a long period of growth that ended with a massive property bubble. So did Japan. 
The UK banks lent far too much than was wise in the 2000s to property companies against too little capital. In doing so they followed a trail blazed by Japanese banks two decades earlier. 
When Britain's party finally ended, the result was an economic wasteland of over-indebted consumers and over-leveraged banks. 
In a repeat of Japan's experience, the credit taps were turned off and growth shuddered to a halt. Japan ended up with a zombie economy in which zombie banks were lending to zombie companies. Firms that would in normal circumstances have gone bust were kept on life support by lenders who themselves were kept in the realm of the living dead courtesy of easy credit and softly-softly financial regulation from Tokyo. 
Worryingly, the UK is showing signs of heading in the same direction. One in 12 companies are able to repay only the interest on their debts and between 5% and 8% of mortgage payers are able to stay in their homes only because lenders are going easy on them. The Bank is particularly concerned about the commercial property sector, which accounts for half of all commercial loans. One third of commercial real estate loans by value are subject to some sort of forbearance, and losses could be higher than lenders are estimating. 
To make matters worse, the Bank thinks accounting rules are allowing lenders to systematically underestimate risks when assessing loans, and that they will eventually face a much higher bill for mis-selling payment protection insurance than they have so far admitted..... 
With investor confidence in banks at a low ebb, drumming up enthusiasm for rights' issues could be tough.
It would be easy if the banks provided ultra transparency.  Then the investors could independently assess the risk of an investment in the banks and invest accordingly.
Bank shares rose slightly yesterday because there had been concern that King would specify what individual banks would have to do and by when. It would be a mistake, however, to believe that the issue of bank capital has been kicked into the long grass. 
The FPC is deadly serious about this because until the banks are sorted out the economy will remain in limbo. Raising interest rates will mean that the policy of "extend and pretend" towards non-performing loans will have to end. Banks will have to be robust enough to cope and at the moment they are not. So, the Bank means it all right. The real question is why it has taken it so long to get tough.

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