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Let's Scare The Banks Into Lending With Capital Raising Threat

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As threats go, the Treasury's warning this week that banks could face a competition probe if they are found to have been charging too much for credit carried all the potency of a toothless chihuahua.

A year-long investigation – and that's optimistic – would hardly address the issue that small businesses need credit now. If the Government is serious about scaring the banks into lending, there is a better way. Threaten them with another round of capital raising.

As Mervyn King, the Governor of the Bank of England, has pointed out, there are two ways of looking at capital – insurance for bad debts and reserves against which to increase lending. Two rounds of fund-raising have pretty much insured the rubbish already on their balance sheets, but the jury's out on the latter. Although Bank data suggest there is currently more credit available than businesses are demanding, the relative cost is higher than ever. Senior officials say pricing is choking off demand, making it effectively the same as credit rationing. Hence the Treasury's concerns.

If banks are found to have been hoarding capital, it won't have been through profiteering and bloody-mindedness alone. It will have been because boards fear the capital already raised is only good for the existing rubbish. Where an Office of Fair Trading probe is a weak threat that offers no solution, the prospect of raising capital might not only scare the banks into lending but also fix the problem.

An arrangement could work much like the US financial stress tests in May. The authorities could instruct those banks guilty of credit rationing to raise more capital within six months or be forced to take taxpayer money. There would be no change to minimum capital ratios and, to protect financial stability, the regulators would make it clear affected lenders are not in crisis but failing to do their bit for the UK economy.

The idea would be anathema to management, whose bonuses are linked to total shareholder returns, as well as existing shareholders, who would be reluctant to see their holdings further diluted. But new investors might seize the opportunity for a cut-price stake now the worst is over, and the country would benefit.

What's more, for once, the regulators would have bared their teeth.


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