Era of cheap money is gone forever

Allister Heath
THERE is one, overwhelming reason why interest rates are going up on products such as credit cards, even though the Bank of England’s base rate remains very low. It has nothing to do with greed, bonuses, rip-off Britain or conspiracy theories – and all to do with the costs associated with the massive amounts of capital the banks are now having to hold. This is a key development which will affect the personal finances of every household in Britain, savers and borrowers alike – and which will make it harder for businesses to raise funds.

The best way to see what is happening is to take a quick look at the details contained in Barclays’ annual results, released yesterday: as part of an extremely strong set of figures which spectacularly vindicated the bank’s strategy over the past 18 months, it announced that it had hiked its Tier One core capital to a massive 10 per cent, giving it a massive buffer against potential problems. It has also built up £127bn in liquid capital, up from £43bn the previous year, while its loans to customers are worth 130 per cent of its deposit pool, also an improvement. Leverage is down from 28 times to 20 times. The balance sheet’s overall size is down 33 per cent to £1,379bn. All of this was necessary and good: the bank is thoroughly cushioned against a Greek default (its exposures to that country are a mere £2bn) and even against another collapse in property prices.

But extra prudence comes at a steep cost: £650m just for the extra liquidity (which earns very little for the bank). Barclays’ average cost of equity is 12.5 per cent (up from 10.5 per cent), while return on equity (excluding the one-off sale of Barclays Global Investors to BlackRock) is just eight per cent. This is shocking and makes no sense; yet other banks are in the same boat. So while Barclays’ profitability is great news, it needs to make even more money to ensure its shareholders’ capital is being put to good use. Some of this gap will vanish when impairments abate; but margins are now unsustainably low for all consumer banks. Barclays made just £612m in profits on its UK retail bank last year (down 55 per cent). Margins need to go up – and they will, slowly but surely.

The era of ultra-easy borrowing is gone forever. We are facing many years of higher costs on loans and lower interest rates on savings accounts as banks readjust, regardless of what the Bank of England decides to do. That is the inevitable price of a safer, more boring financial system.

MANY will be tempted to dismiss yesterday’s consumer prince inflation figures – prices rose by 3.5 per cent over the past year – as irrelevant, a distraction compared with real issues such as the troubles in Greece or surging unemployment. It is true that consumer price inflation is hardly our number one problem (the renewed bubble in housing is much worse); but the Bank’s increasing inability to meet its two per cent target is becoming an issue. Until late 2007, inflationary over- and under-shoots had broadly cancelled themselves out, but subsequently there has been a decisive shift. The price level is now some 2.6 per cent above the level it would have been had the inflation target been met continuously, according to Policy Exchange. This is not a negligible overshoot: it makes a real difference to living standards and also to the UK’s competitiveness. The Bank must get a grip – and fast.