Money rates and the clearing banks
Nicholas Davenport
It has often been said that wars are too important to be left to generals. I would add that money rates in a mixed economy are too important to be left to central bankers. We all know that the Bank of England had a very difficult time last year in trying to cope with a run on sterling, which brought the rate down at one time to below 81.70, but it must have got into a panic when it hoisted Bank rate up to 15 per cent in October. It did no good for sterling, it inflated costs and prices, it knocked businessmen fiat—some housebuilders going into liquidation—and it advertised to the world that Britain had the credibility of a banana republic. Of course, the Governor of the Bank had to get the Chancellor's approval but it is no use blaming Mr Healey. Politicians who have had no experience of the business or monetary world cannot be expected to refuse 'expert' advice. There is only one man in the Cabinet who has had close experience of the business and monetary world and that is the Chancellor of the Duchy of Lancaster. If I were the Chancellor of the Exchequer I would tell the Governor of the Bank, when he next comes to talk about Bank rate, to see Mr Lever first.
The ghastly mistake has now been recognised and Bank rate is being lowered as quickly as possible. The Chancellor in recent speeches has referred to the expectation of a gradual Ian in interest rates and from 19 November up to 7 January Bank rate was lowered weekly a .1 at a time. But last Friday it was cut by to 13+ per cent. It is still, of course, much too high. Investment cannot be planned or expanded at these exorbitant money rates. And if businessmen have been told by the Chancellor to expect a fall in interest rates they will obviously hold off making an investment decision until they think the rate is low enough. But the next important move has now come not from next important move has now come not from the Chancellor but from the clearing banks. They have cut their base rates which had been as high as 14 per cent since last October. This rate has enabled them to charge their second-rate borrowers 19 per cent and even their first-rate borrowers 17 per cent with the result that bank profits have been soaring—and business has been stagnating. When the 1976 bank profits are published shortly it is expected that they will show increases of from 50 to 70 per cent.
It is my perverse belief that if the market responds bullishly to these bumper results bank shares should be sold. For their 1977 prospects are not nearly so rosy. Nor is their future so assured for the following reasons. First, as the rate of interest falls the profit margins of the clearing banks will come under considerable pressure. Their expenses are rising and their freedom of action is being circumscribed by the Bank of England which has reintroduced its 'corset' which sharply reduces the banks' ability to lend.
As regards the future the threat of nationalisation will hang over the banks as long as. there is a credible Labour Party alive. For the immediate prospects of government interference I refer you to the accompanying article by Mr Brendon Sewill. But the future for bank shares is not only affected by the political threat but by the fall in the quality of bank earnings. This can be seen in the statistics of the net worth of a bank as a percentage of their deposits. The decline in these ratios between 1970 and 1975 has been remarkable—in the case of Barclays from 8.5 to 5.2 per cent, for Lloyds from 10.2 to 5.3 per cent, for Midland from 7.9 to 4.7 per cent, for National Westminster from 7 to 5.9 per cent. If we deduct from the figure of net worth' the component which is regarded as the bank's 'infra-structure,' that is, premises, equipment and long-term , trade investments, so as to get at the fixed assets which are more easily realisable, the decline in this ratio as a percentage of deposits is .even more striking—in the case of Barclays from 2.9 to 1.9 per cent, for Lloyds from 3.8 to 0.4 per cent, for Midland from 1.4 to 0,8 per cent, and for National Westminster from 2.9 to 1.2 per cent.
The deterioration of these balance sheet ratios is no doubt a reflection of the massive inflationary growth of bank deposits. And if we look at the cost of administering these deposits we get another impression of the deterioration in the quality of bank earn ings. The percentage increase in the average cost of deposits has been remarkable over the period 1970 to I975—for Barclays 61 per cent, for Lloyds 73 per cent, for Midland 73 per cent and for National Westminster 86 per cent. The average increase of 73 per cent in the cost of bank deposits compares with an average increase in money rates over the same period of around 30 per cent.
The contribution of bank salary rises to this increase in deposit costs has, of course, been obvious. Over the same period of 1970-75 the percentage increase in bank salaries has been for Barclays 170 per cent, for Lloyds 151 per cent, for Midland 190 per cent and for National Westminster 143 per cent. The proportion of overheads covered by fees, service and commission charges fell from an historic average of around 70 per cent to about 20 per cent in the first half of 1976. This meant that the banks had become more dependent on high interest rates to sustain profitability. Increases in service charges for the second half of 1976 may have restored the proportion of overhead costs recovered from fees to around 30 per cent, but it remains true that after a major fall in interest rates, that is, if the banks' base rates fell to 8 per cent, as they did in 1973, the clearing bank profit margins would he minimal. The immediate cut in their base rates which the market has been expecting is in fact from 14 to 13 per cent. It goes without saying that the quality of bank management has not deteriorated at all; in fact, at the top it is better than ever
and Midland has to be congratulated on securing for its chairman that most dis
tinguished civil servant of all time—Lord Armstrong. But the market in bank shares has sensed the deterioration in the quality of bank earnings and the prospect of a fall in
bank profit margins. Over the year bank shares under-performed the market—the index of bank shares falling by II per cent,
although the all-share index is at much the same figure as it was a year ago.
dend yields of 5i per cent on Barclays on" Lloyds, 6.3 per cent on Midland and 6.9 Per cent on National Westminster (which has had property, troubles) are not considered very rewarding.
The political and trade union attack on our clearing banks must be expected to grow and the freedom of action for bank managements must be expected to becoMet less. Montagu Norman once said abou
political criticism of the City: The dogs, bark but the caravan moves on.' Sir Flarolo Wilson has said of his new inquiry: I arn, not taking a bloodhound into the City.' he does not have to, for the bloodhoinwse are already there and they are baying at. thus caravan of the clearing banks in a ferocl° and menacing manner. God preserve the from the bites of Mr Clive Jenkins.
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