Protecting taxpayers may weaken building societies

When ratings agencies downgrade the credit ratings of businesses or countries, it usually becomes more expensive for those businesses and countries to borrow (errr, I guess most of you know that by now; a big hello to those of you from Greece and Ireland).

So the likelihood that Moody's will downgrade the credit ratings of 14 banks means that those banks will probably have to pay a higher rate of interest when they borrow - and they'll probably pass on those higher interest rates to their customers (which is us, as if you didn't know).

Now the main reason why Moody's is downgrading those ratings is that the British authorities plan to impose so-called "resolution" procedures for dealing with banks that face bankruptcy, so that the costs of bank failures fall on the banks' shareholders and creditors rather than on taxpayers.

You'll have spotted the paradox: in trying to protect taxpayers from the costs of bank failures, the government and regulators make it more expensive for banks to borrow, which in turn may make it more expensive for households and businesses to borrow from banks.

What's more, the increase in funding costs falls disproportionately on smaller banks.

The point is that neither investors nor Moody's believe that the biggest, most complex banks would be left by the Treasury to founder and die at the mercy of markets: the likes of HSBC and Barclays would, in the words of Moody's, still benefit from the probability of systemic support.

So the application of so-called resolution procedures to allow banks to fail would increase the risks of lending to smaller banks more than for lending to big banks.

Which means that, relative to big banks, the costs of borrowing for building societies amd tiddler banks would rise sharpest.

That in turn means that the competitive playing field will be tilted even more to the disadvantage of the likes of the Co-Operative Bank and the Coventry, Skipton and Newcastle building societies than was already the case.

Or to put it another way, the Treasury, Bank of England and Financial Services Authority, in reforming the banking system to stabilise it and protect taxpayers, may have inadvertently reinforced the market dominance of the UK's Big Five banks.

Even if the funding costs of Lloyds, HSBC, RBS, Santander and Barclays go up, they won't go up nearly as much as for the smaller banks (which is clear from the fact that the share prices of Lloyds, RBS, HSBC and Barclays have fallen only a bit today).

Or to put it another way, the big issue, of what Lloyds, RBS, HSBC and Barclays need to do for society to repay the implicit support and subsidy they receive from the state, isn't going away.

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