Welcome to Japan-style crisis management Small retailers frequently pin up notices urging people not to ask for credit since refusal might offend. For many small businesses in the UK that sounds uncomfortably like the guiding principle of the big British banks. The so-called Macmillan Gap, named after a committee that looked into the inadequacy of small business funding in the 1930s, has re-emerged with a vengeance, as has the question of how the banks can be encouraged to play a wider role in restoring economic growth. John Plender There is no doubt that part of the problem lies in the banks" inadequate cushion of capital. So it is entirely logical that the Bank of England's latest financial stability report should call for the banks to bolster their capital base in order to boost their capacity for lending to industry and commerce. Yet there is a chicken and egg problem here that relates to investors" readiness to stump up. For as the Financial Policy Committee itself points out, the banks sell at a discount of around a third to net asset value because of uncertainty about the value of assets that are difficult to price and a well justified conviction that the assets are overvalued. The biggest source of overvaluation relates to the form of provisioning required by international financial reporting standards (IFRS), which operates on an incurred loss basis. That is, provisions can only be made where there is evidence that current or imminent impairment will reduce the present value of loans. Banks have only a limited ability under this rule to make full provision for expected losses. Recognition of losses is delayed and the resulting overstatement of asset values in a downturn is likely to be very large when interest rates are close to zero and banks have been keeping default rates low through the forbearance afforded to zombie companies. The report estimates that if provisioning had been carried out on an expected loss basis the UK banks would have held about £50bn of extra provisions before the crisis and would have needed to increase provisions by much less as the crisis broke. That is a salutary reminder of the impact accountancy can have on the health of the financial system and the wider economy. There are other grounds for investor uncertainty, not least the risk that the cost of redress for past bad behaviour vis a vis customers and markets will prove far greater than current estimates. Since a number of expert commentators argue that IFRS encouraged the British and Irish banks to breach statutory capital maintenance requirements, there may also be costly future litigation if shareholders seek compensation for the damage to banks" capital arising from over-distribution of dividends. The FPC also worries that the risk weights banks use in calculating regulatory capital may be too lax. Certainly they are complex and opaque, which is rarely conducive to market confidence. At a more fundamental level there is a big question about what precisely banks would be inviting investors to put their money into. Are these financial institutions turning into low risk, low reward utilities? Certainly analysts have been revising down their forecasts for return on equity in the sector. And there are huge questions about what the banks" cost of funding will be when the ringfencing recommendations of the Independent Banking Commission are implemented. Given these problems the Bank of England hopes that the banks will bolster capital through disposals, business restructuring and other backdoor means. Yet in current market circumstances, this is not easy. It is very easy, by contrast, to boost capital by shrinking the loan book, which is the opposite of what the economy needs. Maybe the other banks could follow Barclays" example in raising contingent convertible bonds, though this seems unlikely to provide a total solution. A more dramatic approach would be to follow the Scandinavian model in the banking crisis of the early 1990s. That involved total nationalisation, making a split between good banks and bad banks and injecting capital into the good bank. The outcome was a timely restoration of credit flows to the economy. In fact the option of taking full ownership of RBS and Lloyds Banking Group was discussed by ministers in the summer. The Treasury was reported to have been profoundly antipathetic. So do not expect anything on this score in the imminent Autumn Statement. We are left, then, with a disturbing level of forbearance, growing potential for misallocation of credit and the unappealing prospect of moving closer to the protracted Japanese model of crisis management, which has caused Japan's gross public sector debt to balloon to 200 per cent of gross domestic product. Where recapitalisation is concerned, it is really back to the old Irish joke. We should not be starting from here. The writer is an FT columnist