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Penny for them: George Osborne should consider that the role of the banks is more complex than the consensus suggests (PA Images) 

Britain's economic outlook, like that of most developed countries, is difficult. Recent data suggests that the recovery is feeble and unimpressive, and that even in 2012 — almost five years from the onset of recession — output may fail to grow faster than the long-run trend rate. Prime Minister David Cameron is reported to have become impatient with his Chancellor of the Exchequer over the economy's sluggishness, fearing that a continued lacklustre performance will undermine support for the Conservatives at the next general election. 

Chancellors of the Exchequers are not magicians. George Osborne has many abilities, but he cannot be expected single-handedly to improve the productivity of British companies. Much that is wrong with the economy in the Great Recession reflects mistakes made under New Labour, while both the Gordon Brown and David Cameron governments have been prepared to sacrifice economic efficiency for the sake of political correctness. For example, it is Cameron, not Osborne, who wants to maintain Labour's policies on renewable energy and the environment, and is pressing that the United Kingdom takes an international lead in reducing carbon emissions. The Chancellor of the Exchequer has no choice in the matter. He has to accept that an official programme to reduce the UK's carbon emissions is under way, that it will raise energy costs for heavy industries and that the adverse effect on economic growth is important. 

Nevertheless, this article will suggest that at least some of Osborne's difficulties — particularly in banking regulation and monetary policy — are self-inflicted and avoidable. Some of its supporters in the City of London may have hoped that, once in office, the Conservative Party would check officialdom's attack on their businesses. In the event the government's reluctance to rock the boat of political correctness has extended to its treatment of the financial sector, now by far the most politically  incorrect part of the economy. In its final stages the last Labour government indulged in a large-scale programme of bank-bashing; in its first year the present Conservative-led coalition has continued that programme. Osborne has gone along with the consensus post-crisis argument that Britain's banks must be more tightly regulated, with higher capital relative to their assets and new restrictions on their operations.  

The focus of debate in the next few weeks will be the final report of the Independent Banking Commission, due out on September 12. The final report will no doubt tweak the conclusions of the interim report, but little more than tweaking is in prospect. The Commission has been chaired by Sir John Vickers, the warden of All Souls College, Oxford, and a former chief economist at the Bank of England. In the interim report Vickers and his team recommended — among other things — a further increase in banks' capital ratios, with systemically important institutions to maintain equity capital equal to a minimum of 10 per cent of their so-called "risk-weighted assets".

This may sound like mumbo-jumbo, but — as we shall see shortly — the technicalities have great social and political significance. (To be vulgar, they could even affect the results of general elections.) The phrase "systemically important institutions" is code for "the large UK clearing banks". So a common interpretation of the Vickers recommendations is that the ratios of equity capital to risk assets at the UK clearing banks will have to be 12 or 13 per cent. Superficially, this may sound reasonable. Given the consensus view that the banks were taking excessive risks before the crisis began, and that the excessive risk-taking was the cause of the slump in economic activity, there appears to be a compelling case for Britain's major banks to operate in future with more ample and comfortable capital cushions.

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December 12th, 2011
6:12 PM
@nalelbro I admit it was not explained fully but it was only a comment. If you disagree with Volker can we hear your reasons.

James Hargrave
October 9th, 2011
1:10 AM
Nothing I have heard of the benighted abd beknighted King from people who had dealings with him in his academic days suggests someone in the least degree fitted to be Governor - indeed he is no banker, he merely rhymes with one. And various other economic historians I talked to in late 2007 were disgusted at his failures of understanding. He is a moral hazard. As far as one could tell he was so busy looking over his shoulder at Europe and in introducing pointlessly modish corporate governance into the Banks' Court of Directors that he failed to see the open grate in the middle of the pavement and fell straight down it. But, somehow, this ass keeps landing on his feet.

October 2nd, 2011
9:10 AM
As always? an informative and interesting article. However, No more boom and bust. G.B. He was parroting the high priest of neoclassical/neoliberal economics – R. E. Lucas. In the 2003 presidential address to the American Economic Association, Robert E. Lucas, Jnr of the University of Chicago said: “My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

September 8th, 2011
12:09 PM
@GOODCRED You say this as if it is received wisdom and a "given". Not only is it not correct, it is a delusion to think that retail banking is by definition safer than investment banking. Au contraire, as any glance at Northern Rock's or numerous other lenders mortgage books amply demonstrates. Please try not to regurgitate uncritically politically inspired nostrums.

September 2nd, 2011
9:09 PM
but deep down politicians know separating investment banking from retail banking would be the best way to reduce the risk. The tax payer wouldn't have to bail out investment banks if they fail.

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