It's time to lift the foot from the economy's windpipe Take liquidity rules which require banks to hold gilts on their balance sheets to fund themselves should interbank markets freeze as in 2008. At the end of 2008 those gilt holdings on the balance sheets of banks and other lenders amounted to £25.7bn. They're now £398bn. This is bank funding tied up in gilts delivering a negative rate of return. The cash is safe. But far from doing anything (except finance the country's deficit and keep George Osborne's cost of borrowing down) it's value is shrinking in real terms. In effect the money is under a gigantic regulatory mattress, growing mildew. While all this cash is tied up in gilts, banks have to find alternative sources of funding to support their lending. That means competing for depositors. To do that banks are offering higher and higher rates of interest on savings but then have to charge higher rates of interest to borrowers, further dampening demand for loans. There's a similar squeeze as a result of new capital rules. For any given type of lending activity such as residential mortgages, commercial property or infrastructure investment, banks are required to hold higher and higher levels of capital to absorb potential losses should loans go bad. UK banks have in fact got to the new Basel 3 capital standards but these are not due to come into force until 2019. US and European banks are moving towards these standards at a glacial pace. We've won the race to have the safest banks in town but only by curtailing their core activity of lending. To raise all this extra capital banks could ask their shareholders for the money. But given where stockmarkets are that's not going to happen. So instead to build up capital banks reduce net lending, keeping more and more capital on their balance sheets as outstanding loans are repaid - so called deleveraging. This isn't just hitting riskier, short-term lending. Many activities crucial to the long-term health of our economy, such as funding for infrastructure projects, are being abandoned by banks because the amount of capital the Financial Services Authority demands is punitive. Reorganising their businesses to comply with the Independent Commission on Banking is adding further costs. Not surprisingly then small businesses in Germany, which has no ICB or gold plated, super equivalent regulations like the UK, can borrow at 2pc-3pc while UK rivals have to pay 6pc. Some regulators such as Alastair Clark and Andrew Bailey at the Bank of England are hinting the FSA has got it wrong and the regulatory foot may be removed from the economy's windpipe in future. But, as with the reforms I suggested yesterday, action needs to be taken now to stop stagnation turning to slump.