Mandelson on the banks

Mandelson isn't pleased with UK banks. He thinks they are over-reacting to the credit crunch.

"The banks have experienced a sharp liquidity crisis. They have lent too much at too cheap a price for too long. But they are now overreacting to that, in my opinion, in too conservative and restrictive a way.

They are in danger of substituting one set of problems for another, and in the process doing themselves further damage by under lending and not strengthening their balance sheets and profits in the longer term. They are close to cutting off their noses to spite their faces."

I found this intervention from Mandelson deeply depressing. Nu-Labour have little understanding of banking. Yet Mandelson's comments seem to be paving the way towards direct state intervention in lending decisions. When the government takes control of lending, the UK banking disaster will be turned into a calamity.

See-saw banking

Banking isn't a see-saw, where there is too much lending one day, and not enough the next. It is a regulated activity. If the regulators slacken off, banks will take advantage, which is what they did for the last decade, expanding credit at double digit growth rates.

However, the days of slack supervision are supposedly over. The FSA is asking banks to increase their capital adequacy ratios. In the absence of a massive capital injection, banks have to restrict lending in order to meet FSA targets.

As such, it is hard to see how Mandelson's demands for more lending can be squared with the FSA's push for improved capital ratios.

Bank balance sheets - the smaller, the better

The recent conservatism of banks comes directly from the appalling state of their balance sheets. It is a recognition that banks became too big during the bubble and now need to shrink. It put it another way, banks have too many loans and not enough capital to absorb losses.

Mandelson doesn't seem to appreciate this problem, because if he did he wouldn't be pressurizing Banks to go out and lend. If banks again went on a borrowing binge, leverage ratios would go up, and banks would be even less able to absorb any future rise in default rates.

Big is not always profitable

A bank does not strengthen its balance sheet by increasing lending. Nor does profitability necessarily increase when lending goes up. Banks are profitable when they have strong lending books and low unit labour costs.

Mandelson doesn't seem to appreciate the hazards of an expanding lending book. With today's deteriorating economy, new loans could easily go bad. With increasing default rates, any bank following Mandelson's exhortations might easily find themselves on a fast track to bankruptcy.

State owned banks - the first step towards socialism

Mandelson's comments also scare me.

Now that the government has a major equity holding in the financial sector, it may only be a matter of time before Mandelson instructs state owned banks to begin lending. We could easily see the government introducing credit growth targets, which would be one more crafty step towards socialism.