Not all banks were given state handouts

Allister Heath
ANOTHER day; another row about banking profits, bonuses and the future of the City. The nationalised Northern Rock&rsquo;s numbers were poor as expected &ndash; but for some reason, the pundits are more concerned with banks that are doing reasonably well. And not any institution: they couldn&rsquo;t care less about Standard Chartered, a well-managed group which announced higher profits yesterday. Rather, most commentators remain obsessed with the only two truly profitable High Street banks (Santander, of course, is Spanish). The most intriguing line of attack is the claim that Barclays has in fact been propped up by taking part in the Bank of England&rsquo;s special liquidity scheme and by making use of government guarantees to issue bonds. Others have argued all banks, even HSBC, enjoy implicit subsidies because they would be deemed &ldquo;too big to fail&rdquo;. <br /><br />None of this amounts to an RBS-style bailout, however. Following an argument first made in 1873 by Walter Bagehot, our current banking system is based on the premise that central banks will always act as a lender of last resort to the banking system. I&rsquo;m not claiming that this is a good thing, as it promotes moral hazard; but it is the assumption under which financial institutions have been operating for decades. <br /><br />Banks lend long (by offering 25-year mortgages) but borrow short (by competing for deposits); this &ldquo;maturity transformation&rdquo; might therefore occasionally mean that otherwise solvent institutions suffer from temporary illiquidity. Some argue that banks could tackle this even without a central bank. But in Bagehot&rsquo;s model, which is accepted by regulators, a key task for the central bank &ndash; which acts as a bankers&rsquo; bank &ndash; is to extend liquidity on commercial terms, if it is ever needed, to solvent institutions facing a temporary cash problem. <br /><br />Liquidity may be required under two scenarios: an irrational run on a bank, triggering an unmanageable withdrawal of deposits; or a freezing up of the money markets for reasons unconnected to the bank. Many of the actions taken by the authorities didn&rsquo;t conform to Bagehot&rsquo;s narrow prescription: the state&rsquo;s recapitalisation of some banks, and the nationalisation of insolvent lenders. Institutions with solvency problems &ndash; a situation which occurs when a bank is unable to raise extra capital and that its liabilities overwhelm its assets &ndash; were given extraordinary, costly help.<br /><br />The special liquidity scheme, however, was compatible with Bagehot&rsquo;s criteria; it was the kind of service that all banks have always been told they can expect (at a cost) when the going gets tough. Banks swapped illiquid assets for Treasury Bills; responsibility for losses on loans remained with the banks. The help afforded to healthy firms was of a completely different kind to that offered to Northern Rock or RBS. The same is true of the wholesale guarantees: banks paid the Treasury and in return it guaranteed debt issuance, helping them surmount dead credit markets. <br /><br />What about &ldquo;too big to fail&rdquo; guarantees? Under a bail-out, equity holders would lose; the risk premium on shares is unaffected. It is lower than it should be on bonds, so there is a subsidy here. But the bottom line remains that Standard Chartered, HSBC and Barclays remained independent, private firms throughout the crisis and should be applauded for having done so.