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Sustainable Economy > Published by Duncan Weldon, September 18th 2009 at 12:15 pm

Osborne: Banks must rebuild balance sheets, and they must not

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George Osborne’s speech on Tuesday contained an interesting conundrum.  He argued that:

“If the banking system remains undercapitalised – with so called ‘zombie banks’ – then the monetary transmission mechanism will be broken.

“As happened in Japan, lower policy rates will be absorbed by the banks in the form of higher margins and profits in order to rebuild their balance sheets, instead of being passed on to households and businesses.

“Monitoring bank margins and the extent to which lower interest rates are passed through to consumers should be a key focus of economic policy.”

But later he argues:

“Indeed, if banks pay out huge bonuses on the back of taxpayer support instead of using profits to rebuild their balance sheets, that is not only bad for the broader economy, it is bad for the City itself.”

So, banks must be stopped from paying bonuses as they need their profits to rebuild their balance sheets while at the same time it would be a bad thing if banks increased their profits to rebuild their balance sheets?

Meanwhile for all Osborne’s worries about banks absorbing the lower policy rates and not passing them on, Bank of England data shows this is not the case. The spread between floating rate mortgages and deposit accounts has actually fallen over the past year.

The spread between floating rate mortages and deposit accounts is falling

  • http://twitter.com/shamikdas/status/4076661649 Shamik Das

    RT @leftfootfwd: George Osborne contradicts himself in the same speech: http://bit.ly/4xXQWB

  • http://www.mtpt.co.uk Matthew Taylor

    It helps if your second quote was as fulsome as your first. He went on to say:

    “nd it is important to remember that we are underwriting these profits for a purpose – to help recapitalise the banks and support the broader economy, not so that they can be paid out as huge bonuses or distributed as excess returns to shareholders.

    Indeed, if banks pay out huge bonuses on the back of taxpayer support instead of using profits to rebuild their balance sheets, that is not only bad for the broader economy, it is bad for the City itself.

    It is not in the interests of the financial services sector as a whole to have a small number of government-subsidised players distorting competition by using taxpayer support to bid up remuneration levels.”

    He’s making two different points, both of which bear on recapitalisation: first, that the need by banks to retain profits to recapitalise will dampen the transmission of changes in the policy rates of interest, and this needs to be monitored as those changes in policy rates are not primarily for the benefit of the banks; and second, that the state owned/subsidised banks must use that ownership capital/subsidy for the purpose for which it is intended – recapitalising themselves, not using it to increase remuneration (and thereby distorting the market).

  • http://duncanseconomicblog.wordpress.com/ duncanweldon

    Matthew,

    So does he want net interest margubs to expand or contract? I agree there is a tension, do we want banks to increase margins and build up capital or do we want them to pass on lower rates? I.e. does he want the ‘spread’ line on the graph to move up or down?

    The problem with Osborne’s speach is that he seems to want both.

  • matthew bond

    Very good Duncan. This conundrum is why Osborne’s claims that lower interest rates can drive the recovery are fallacious. Banks will always be tempted to increase net interest margins. It makes sense for them as individual firms. Banks face a collective action problem that can only be resolved by strong government action and fiscal stimulus.

  • http://twitter.com/tugsandtost/status/4077314183 matthew bond

    RT@leftfootfwd George Osborne contradicts himself in the same speech: http://bit.ly/4xXQWB

  • http://twitter.com/tom_miller85/status/4077673827 Tom Miller

    George Osborne contradicts himself in the same speech: http://bit.ly/4xXQWB

  • http://twitter.com/chrisplol/status/4077952150 Chris Paul

    Good skills from GOO RT @tom_miller85 George Osborne contradicts himself in the same speech: http://bit.ly/4xXQWB

  • http://twitter.com/chrisplol/status/4077982688 Chris Paul

    Good skills from GOO Tom adds RT @tom_miller85 Sorry, RT @LeftFootFwd George Osborne contradicts himself in same speech http://bit.ly/4xXQWB