No reason for governments to encourage folly.

Andrew Smithers
Financial Times (Letters) , 25th September 2009

In your editorial, "G20 must not let unity unravel" (September 24), you argue that banks need a great deal more equity capital and quote the International Monetary Funds's estimate of $1,700bn. You then suggest that "such rules must be implemented gradually, lest undercapitalised banks meet them by cutting lending". This is exactly 100 per cent wrong. So long as banks know that they will need to massively increase their equity ratios, bankers will be unwilling to expand their lending and will be delighted with the high margins that result, together with the high remuneration for them that this will entail whatever regulations are introduced over bonuses.

In order to remove this obstacle to lending, governments need to insist on bank equity ratios being increased, within say the next six months, to levels that are a multiple of the current ones. The dramatic rise in banks' market capitalisation over the past few months makes this the ideal time for action, though governments must nonetheless be prepared to underwrite the issues and to increase their ownership of banks' equity should other investors be unprepared to provide the amounts necessary.

Until it is agreed that banks are adequately financed, their unwillingness to lend will act as a constraint on economic recovery.

Governments will of course be nervous of strong action, and will be told by their advisers: "That would be a most courageous policy, minister." While it can therefore be argued that sensible policy measures are unlikely, this is not a reason to encourage folly.