View From City Road: Banks have not learnt the lessons

It has taken six months for banks to forget five years of hard lessons. I bang my head against my desk every morning when I come in and hear the latest things they have done.

These are the words of a clearing bank head of corporate lending who has just heard of yet another aggressive loan to a big UK company on a wafer-thin margin. US, German, French, Japanese and British banks are all back in the London market with a vengeance in sterling and dollar lending.

Bankers are as aware as anyone else of the appalling cycle of careless lending followed by heavy losses from which the financial industry has just emerged.

But crowd psychology has taken over once more. Everyone knows the stampede is dangerous. Individual lenders seem powerless to stop it.

The effect on margins has been visible all year. In one recent deal an American bank gave a British company a pounds 10m loan facility at 7.5 basis points (0.075 per cent) over the cost of funds.

That cannot possibly be profitable. Market share is again being put above all other considerations.

It might be possible to justify lending on such an aggressive basis if the purpose were to secure customers for more profitable services such as securities issuing. If the loan is to a good credit risk and well secured, the fees from investment banking services might more than make up for the low margin. That is certainly how the big London clearers rationalise such lending - as a loss leader.

There are new and rather more worrying developments, however. Cut- throat competition is prompting banks to agree much looser covenants, sometimes none at all, enormously weakening their bargaining power when thing start to go wrong.

There is also evidence that banks are now beginning to lend to higher- risk customers at very low margins. One pounds 10m bad debt would wipe out a year's profit on more than pounds 1bn of loans at the ridiculously low margins seen lately.

Chemical Bank said last month it was concerned by the weakening of covenants and was planning to take action to stop it. That brought hollow laughter from rivals, since Chemical's aggression on margins has made it the bank they most fear to meet in competition for a loan deal.

There are two broad reasons for what is happening. Loan demand is weak against an oversupply of funds to lend, and companies are switching from bank borrowings to bond issues and private placements of debt.

More fundamentally, large banks are never allowed to go bust, so recession has left enormous overcapacity worldwide. Responsibility for preventing this becoming another lending binge, 1980s-style, must lie with central banks.