Sajid Javid: The news from Dubai is a big blow to the UK banking sector

Sajid is a businessman and private investor.  He was previously a senior Managing Director at Deutsche Bank AG.  In this Platform he argues that current financial crisis in Dubai will hit UK banks hard and makes the need for action to resolve our banking problems even more urgent.

If you needed any evidence of the fragility of the global economy then consider the announcement 48 hours ago by Dubai World that it will be unable to repay its debts.  Although not technically a default (yet) by the government of Dubai itself, for all intents and purposes that’s exactly what it is.  Dubai – a city-state that modelled itself as the new Singapore or Hong Kong – turns out to be Argentina.

On the back of this news, global stock markets had their worst day in 8 months.  The cost of buying insurance on sun-drenched Dubai’s bonds hit Icelandic levels this morning.

The UK economy needed this news like a hole in the head.  UK banks, led by RBS and HSBC, have the largest exposures to Dubai of any other major banks in the world.  The exact exposures are not yet clear, but don’t be surprised to learn that a significant portion of the losses from this $60 billion default will rest on UK shoulders.

No major country is in as bad an economic shape as we are.  I am sure you have all heard the numbers, so I won’t bore you with them now.  But as Europe and the US start to grow again, and Asia is almost booming, our situation continues to deteriorate.  The events unfolding in Dubai right now only go to underline how fragile the current “stability” we see really is.

George Osborne is right to focus cutting our fiscal deficit drastically and to talk about reducing corporation tax, but this is not enough.  As Fraser Nelson and Mark Bathgate highlight in this week's Spectator, we are not going to recover from this almighty mess until banks start lending again.

This means that UK banks need to fess up and come clean.  How large are their exposures and to whom? What form? What reserves do they have? What do they expect to realistically lose? How much fresh capital do they need to function as a bank again?

We need a full, clean, independent audit of every UK bank.  Once we know the extent of the damage, each bank can try and raise the capital it requires from private investors.  If any bank is unable to, then that bank should be merged with a stronger institution or wound up in an orderly way.

Right now, the markets just don’t believe that our banks are being truthful about the problems the face.  In turn, the banks aren’t getting the capital they need, so are instead squeezing existing customers as well as not lending.  This will continue until the government forces a clean up through a rigorous independent audit.

If anyone wants any proof of the lack of transparency and faith in our banks, look no further than this week’s news that the government made a secret loan of £62 billion to RBS and HBOS a year ago.  Although the loan has now been repaid, what else have we not yet been told about the government’s actions during the financial crisis?  This uncertainty will only go towards keeping the real cost of borrowing for banks stubbornly high, despite record low base rates.

As Nelson & Bathgate rightly say, comparing our situation to the successful restructuring of Scandinavian banks in the early 1990s:

“When investors became confident that there were no more hidden surprises in the Scandinavian banks, money returned quickly.  As it did, the banks started lending to their customers.  The wheels of a healthy economy...started to turn again.  And so they can in Britain, with the correct medicine.”

How I wish this shabby government would do the right thing.  But, I fear, we are going to have to wait for the next Conservative government.