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King and banks' capital

• Robert Peston
• 23 Jan 08, 08:29 AM

A contained a stark analysis of what may lie ahead for banks.

Mervyn King said that central banks could not fix the fundamental problems in money markets, which underlies commercial banks reduced appetite for lending to all of us.

"The solution to the underlying problem does not rest with them [central banks] but with the banks and financial markets" he said. "Banks must reveal losses promptly, and, most importantly, raise new capital where necessary".
When I was a boy, if the Governor of the Bank of England had made such a statement there would have been a minor earthquake in the City.

It would have been taken for granted that he knew that the balance sheets of one or more of our big banks were shot to pieces. And that massive rights issues of new shares, to raise capital, were undoubtedly on the way.

That was then, when the had direct responsibility for supervising the health of banks and the elevation of the Governor's eyebrow could change climatic conditions.

Since Gordon Brown's regulatory reforms of 1997, the Bank has a more indirect relationship with banks: it is responsible for the stability of the financial system rather than the health of individual institutions.

But that doesn't mean his words can be dismissed as just another view, albeit rather more intellecutally robust than most analysts'. If the Governor really has no special knowledge of conditions in the City, then we're probably in serious trouble.

And Mr King doesn't think the problems at the banks are just that they have failed yet to make a clean breast of their losses on their foolish investments in securities linked to sub-prime lending - though we can expect more losses out of that mess of their own making.

King opined that "there is a risk that weaker activity and lower asset prices could result in another round of losses for banks and a further tightening of credit conditions".

He implied that the recent sharp falls in the share prices of banks weren鈥檛 wholly irrational.

After the tumbles in their share prices, the historic dividend yields for some of our biggest banks rose to astonishingly high levels, between 8 and 11 per cent - which suggests that investors fear that their dividends will be reduced.

If King is right, and some banks need new capital, cutting their dividends would be one way of achieving that. At a time of such economic uncertainty, cutting the dividend might be smarter than issuing shares.

To be clear, there is no suggestion that any of our banks are in serious difficulties. But the bad-news season for them may not be over.

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