Bank cash plan sparks lending fear

Demands for banks to hold an extra £25bn to guard against future financial shocks have been criticised for potentially stifling cash-starved businesses.

The Bank of England’s Financial Policy Committee (FPC) said banks needed to meet the shortfall to bolster their balance sheet strength in the face of a potential £50bn blow to their reserves over the next three years.

It said they will need to find the £25bn by the end of the year, either by raising new capital or restructuring their balance sheets.

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Lenders have already drawn up plans to fill around half the shortfall, which is less than many feared in the City after the Bank warned last November it could reach as much as £60bn.

But experts warned that plans to force banks to raise capital will threaten the recovery by tightening the lending squeeze for small businesses.

The CBI business group yesterday said it was “difficult to see” how banks could bolster their capital cushions without restricting lending.

Richard Barfield, banking director at PricewaterhouseCoopers (PwC), added they may be forced to cut credit available to borrowers, given that there is little appetite in financial markets to invest capital in the sector.

“Without external capital-raising, the principal way for banks to achieve more demanding capital ratios would be to reduce lending or carry out more de-leveraging, which is not conducive to economic growth,” he said.

Business secretary Vince Cable also weighed in, hitting out at the FPC’s hardline stance.

“The idea that banks should be forced to raise new capital during a period of recession is an erroneous one,” he told Sky News.

“This FPC exercise will prolong the time it takes for the British economy to recover by further depressing already-weak SME lending,” he added.

Bank governor Sir Mervyn King, who chairs the FPC, insisted the measures would not hold back lending and were vital to help the economy recover in the long run.

He said: “Far from reducing lending, today’s recommendations will support lending and promote growth.

“A weak banking system does not expand lending. The better capitalised banks are the ones expanding lending and it is the weaker capitalised banks that are contracting lending.”

He also said that the capital shortfall identified by the FPC was “perfectly manageable” and stressed taxpayers will not need to stump up any more cash, having already footed the bill for bailouts of state-backed lenders Royal Bank of Scotland and Lloyds Banking Group.

“The meeting of these recommendations does not require additional public funds – banks can meet the recommendations in other ways such as through restructuring,” he said.

The FPC revealed the capital shortfall as it warned that over the next three years banks could suffer around £30bn in bad debts on exposure to property and vulnerable eurozone economies, another £10bn in conduct costs such as mis-selling claims and about £12bn on a more prudent approach to risk.

The FPC did not disclose which banks have to boost their capital reserves, but lenders have already started taking action.

The Co-operative Bank, which is reportedly facing a £1bn shortfall, recently announced the sale of its life insurance and asset management arm to Royal London and will also offload its general insurance business.

The incoming Prudential Regulation Authority, which comes into force on Monday as part of a regulatory overhaul, will ensure banks and building societies have capital ratios of at least 7 per cent by the end of 2013.