Have the banks not learned?

In the light of the bonuses paid by Britain's big banks over the past few weeks - including the 100 or so new millionaires created at the state-owned Royal Bank of Scotland - one might have thought that the crisis, which enveloped the financial system in 2007-08, was over.

But this is far from the case. Although the American government has sold off the stakes it took in the US banks in 2008-09, the UK still finds itself the owner of Northern Rock, holding 83 per cent of the shares in RBS and more than 40 per cent of Lloyds Banking Group.

The failure to dispose of these stakes is down to the continued work of the Sir John Vickers Independent Banking Commission, due to produce its interim report this month. Uncertainty over the future shape and size of the high-street banks makes it difficult to conduct a share sale. However, investment bankers Deutsche Bank have been asked to look at possible sales options for the healthy arm of Northern Rock.

But it is not just uncertainty over the future size and shape of the banks which makes it difficult to offload the shares on the stock market. The "Prudential Risk Outlook" report from the regulator the Financial Services Authority (FSA) makes it clear that our high street banks still have serious problems. Among the most serious is over-exposure to the property.

The FSA reports that loans to commercial real estate (CRE) represent one-third of UK banks' total lending worldwide and about half of their lending to Britain's non-financial companies. Prime CRE prices such as those in London's West End and the City have recovered. But secondary prices have failed to bounce or have fallen even further. More than 20 per cent of outstanding CRE loans in Britain are in breach of financial covenants. So far, lenders have shown unusual patience in demanding repayment. But that may not last. Without robust recovery for the whole economy there is unlikely to be an associated rise in property prices.

What is as worrying is that as the banks seek to rebuild their profits and bonus levels for staff they seem to have forgotten many of the lessons of the events that led to the "great panic" of 2007-2009. That crisis, for those who have forgotten, was based around the banks' holding of toxic debt in the shape of American sub-prime mortgages. The attraction of such assets were the generous yields not available on normal commercial lending.

The FSA now fears that banks may react to low profitability on traditional loans by looking to do something more risky. It notes that trading in lower-rated credit securities has restarted. It has urged the banks to ensure that the amount of assets tied up in such debt is tightly controlled and risk management systems secure.

In my own conversations with the bankers, they say that less cautious lenders, anxious to rebuild their businesses, are engaging in so called 'covenant lite' loans. These are advances made without the necessary risk checks. The banks, in their desire to kick start business and fuel a profits and bonus culture, are repeating the mistakes of the past.

How worried should we be? As taxpayers we must be concerned because of the large shareholdings which we still have in larger banks. As customers of the banks we should also be concerned at their dependence on the property sector and the lack of caution shown. This is a particularly difficult period for the regulators. The new Basle III rules, which will tighten capital requirements, have yet to be fully implemented. The banks could yet face new serious problems as a result of lending to euroland countries in trouble. Barclays in Spain, for instance, has already had to make considerable write-offs.

Finally, there is a small window of opportunity for so called regulatory arbitrage - banks taking advantage of gaps in supervision - as many of the new rules in the UK and across the Atlantic have yet to be instigated, and regulation of the British banks is passing from the FSA to Bank of England.

What is remarkable is that the banks still feel confident enough to pay massive bonuses. Several thousand bankers and traders in the City are thought to have received cash and shares worth £1 million in the past year.

At a time when much of the country is facing a squeeze on incomes and small businesses are struggling to survive, this looks to be a distortion of values. Yet the government remains cautious about taking the bankers on for fear of undermining the value of the state-owned shares and the City's role as a world class financial centre.

Alex Brummer is Daily Mail City Editor

    Last updated: 11:41am, March 31 2011