Structural change is needed, says MPC newcomer
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The UK banking system needs to be overhauled before it can be weaned off public support, the newest member of the Monetary Policy Committee has warned.
Adam Posen used the occasion of his first speech as an external member of the Bank of England’s MPC to outline his concern that the financial system as it is currently structured is not equipped to come off public support and sustain recovery in the private sector.
Posen told his audience at London’s Cass Business School that if recovery is left to the private banking sector without taxpayer support it would mean recovery will be shorter, weaker and more erratic than it should be.
He says that although the government has been right to inject the huge amount of money it has done into banks so far there are limits to how far the public purse can stretch.
Posen argues that if plans from both the government and the Bank to stimulate the economy work, the basis for a return to recovery will be sound.
But he warns that credit conditions remain tight for many businesses as banks and lenders re- build their balance sheets and tighten criteria.
Posen says: “Some harm is inevitable, especially when financial crises of the scale we have experienced occur, but the extent of lasting damage is far from out of our hands.
“That’s why, in testimony before the Treasury Select Committee and the US Congress’ Joint Economic Committee I have argued that the banking system must be fixed before macroeconomic stimuli can be withdrawn.”
He adds: “The alternative is likely to be a stillborn recovery, a double-dip recession and persistently slow growth.”
Posen argues that experience of the US savings and loan crisis of the 1980s, the Asian financial troubles of 1997 to 1999 and Japan’s recession of the 1990s shows that economies that either fix their banking systems quickly or have a range of channels through which to provide capital to businesses recover more strongly than others.
He says: “It helps to have at least one spare tyre in the system. I am concerned because the financial system in the UK does not seem to have a spare tyre for the provision of capital to non-financial businesses when the banking system pops a leak.”
He also says that the Bank is limited by the type of assets it can purchase through the quantitative easing programme, which could also harm any recovery.
Posen adds that there is an uncomfortable parallel with the Japanese financial system when that country’s economy began to recover in the mid-1990s but was unable to sustain this.
He says: “The closer one looks the more worrisome this parallel becomes, given the concentration of the UK system in the hands of a few large but still troubled banks, and the relative underdevelopment of alternative non-bank channels for getting capital to non-financial businesses.
“We need a system with sufficient competitive pressure to provide traditional lending to non- financial business rather than one beset by ‘too big to fail’ institutions that engage in relatively unproductive speculative behaviour.”
He adds: “We need this structural change to generate sustainable growth, not just to diminish systemic risk - although either would be reason enough.”
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