Brexit isn't helping the economy – as we expected

The talk of a second EU referendum has died down. The legal challenges to the Government’s policy of withdrawal from Europe are yet to yield much excitement, let alone a result. We have Eurosceptics in charge of making exit a success. We have a Prime Minister whose mantra is "Brexit means Brexit", though of course no one yet actually does agree about what Brexit means.

Britain, in other words, has made its bed and is getting used to it. One of key providers of comfort swung decisively into action last week. The Bank of England’s multi-weaponed support for the economy was well-timed and intended to impress, which it did. One of the deep strengths in the response attracted comparatively little attention – the meticulous care the Bank has gone to to ensure that abstruse "open-market operations" will feed through rapidly to easier credit for consumers, home buyers and companies.

In this, the Bank has been greatly strengthened since it regained regulatory control of the banks, taking over from the old Financial Services Authority, which had a mixed record during the financial crisis of 2008-11. As Mark Carney, the Bank’s Governor, told journalists last week, this enables the Bank to “look under the hood” at the motor of the financial system and gauge how smoothly it is running, and to speak directly to banks and building societies.

Not the least important of the Bank's initiatives was a relaxation in the amount of capital, or reserves, the commercial banks are required to hold to carry on the business of lending. The lower the reserve, the more money can be lent to hard-pressed industrialists, retailers, farmers, students and anyone else in the economy who needs that support to make productive investment.

Of course, here we encounter a dilemma, for running too low a level of reserves, and lending too extravagantly to too many poor risks, was the reason the banks got into so much trouble in the first place. Yet forcing the banks to sit on their capital in case of a crisis means the economy will be weaker, with more job losses and more debt write-offs damaging bank profitability and, indeed, denuding their reserves.

It is difficult for all of Europe's central bankers to navigate a middle course between Scylla and Charybdis (and it is the Italian banks that represent the single weakest link in the chain). As the European Banking Authority's recent stress tests showed, a severe slowdown across Europe – and one more likely now than before the June referendum – would mean banks would need to make calls on their shareholders that may be impossible to meet, such is the scale of the funds that may be needed. If it then falls to governments to, in effect, completely nationalise their banking systems – as was done to a significant extent in 2009-10 – we can only hope that they have the financial headroom to do so, with support from international organisations.

The vicious interplay between gathering recession and an enfeebled banking system, then, remains a potent, if arcane, threat to financial and political stability, just as it did a decade ago. The worry is really whether central banks and governments have the capacity to support their weaker banks.

That cannot be assumed.

It is unthinkable, but not impossible, for a major British or European bank to go bust. The £2bn loss reported by majority state-owned RBS last week – a figure that will be largely shouldered by taxpayers – is a stark reminder that the big banks are far from being restored to full strength, even though they are far more robust than they were at the start of the crisis. A combination of an imminent Brexit recession (or near recession), running down capital below where it otherwise would be, the continual distraction and cost of fines for past misselling and misbehaviour, and the rapid transmission of financial troubles in one corner of the world to become another global crisis is a huge dormant threat to the West’s prosperity. Mr Carney and his counterparts will need to keep a very close eye on what’s going on under the hood.

It doesn’t make any practical difference now, but is worth saying for the record: Brexit isn’t helping.