It is whether they can convince investors that it is safe to provide them with funding at reasonable spreads over Bank Rate without central bank support. As the Financial Policy Committee (FPC) noted in its recent Review, UK banks are still some way from being able to convince the market in this respect. Regulators, who from 1 April will be in the Bank of England’s new Prudential Regulation Authority, are now working hard to ensure that banks are making adequate provisions for future losses, the likely costs of regulatory penalties and compensation to customers, and stating the riskiness of their assets in a more prudent way. A lesson from past crises, and also from this one, is that it is important to act now rather than hope that problems will go away of their own accord. As the FPC said last December, it is likely that banks will be required either to raise more capital or to restructure their businesses or exposures, and the FPC will review the position in March. There is no single remedy appropriate to all banks. With proper implementation, there is no reason why the two banks with significant state shareholdings could not largely be back in the private sector within a relatively short period. After all, in the United States banks that received state support are already back in private hands. Restoring our banking system to full – and transparent – health is only one of the structural changes that will be necessary to rebalance the economy.
But, as the President of the European Central Bank, Mario Draghi, has said on many occasions, only politicians can produce lasting solutions to the problems facing the euro area, whether by restoring competitiveness to the periphery or creating a framework for a transfer union. The euro area illustrates a major problem for the world economy as a whole – the need to rebalance domestic demand away from countries with trade deficits to those with trade surpluses. Without that, an increasing number of countries are coming to the view that only a lower real exchange rate will provide the stimulus to demand that their economies require. Several have taken action to achieve that end. That is a recipe for competitive depreciations, what some have called “currency wars”. Yet the existing configuration of exchange rates is unlikely to deliver stability. For almost two decades the world has struggled with, but failed to resolve, this problem. So it is hard to be optimistic about how easy it will be to manage the resulting tensions. The fall in our own exchange rate, of some 25% between late 2007 and the beginning of 2009, has reduced the gap between our exports and imports in real terms from around 3½% of GDP to around 1½%. But the persistence of the current account deficit is evidence that an adjustment of sterling of that order was certainly necessary for a full rebalancing of our economy.