There's a good reason why the banks can't drop their lending rates

If Banks Behaving Badly was a sitcom, its gags would be pretty grim stuff but I suspect it would still top this winter's viewing ratings. The idea that banks behaved very badly in the boom years and are continuing to behave badly now by failing to pass on interest-rate cuts to borrowers and by pursuing brutal repossession policies is a recurring theme of daily conversation.

In bus queues, in bars, around water-coolers, we routinely vent our resentment towards the banks that hold our money and our mortgages. So much so, in fact, that Gordon Brown and Alistair Darling must barely be able to believe their luck: these high-street institutions are seen as even more incompetent and conniving than the Government itself. They have provided the opportunity for a classic New Labour smokescreen operation, in the design of which that past-master Lord Mandelson has no doubt had a hand.

Circumstances have given Brown and Darling more power to boss the banks around than ever before. So the headlines were "Brown blitz on banks" and "Brown to stop wave of repossessions" in anticipation of the Queen's Speech; and when the Bank of England slashed interest rates to a 57-year low of two per cent, the Chancellor was instantly there to declare: "I want to see these cuts passed on."

But they have not been passed on. The cuts of 1.5 per cent in November and another one per cent last week have been awarded in full only to mortgage borrowers with "tracker" deals that have no minimum-rate clause in the small print.

Halifax, Britain's biggest mortgage lender and (through the taxpayer-backed merger of its parent HBOS with Lloyds TSB) one of the banks over which ministers supposedly now have the whip-hand, cut its standard variable rate by only 0.25 per cent on Friday. Banks which did pass on this month's cut in full were those that failed to pass on last month's.

In response, bank chiefs have been "summoned" to Downing Street for another lecture this week on their social responsibilities, while influential Labour MP and Treasury committee chairman John McFall hinted at full nationalisation if they continue to hold out against the Government line. And quite right, too, you may be thinking.

The Government has invested £37 billion of our money in new capital for banks to repair their boom-time follies, and is right to expect in return that the banks will ease the recession's impact on homebuyers and businesses.

Anyone who was around in the early Nineties will recall how, without Gordon Brown to direct them, the banks made that recession more bitter than it might otherwise have been through punitive, panic-driven loan rates and repossession policies.

Both those lines of argument carry some weight but not nearly as much weight as the Government would wish us to believe.

First, the relationship between the official Bank Rate, now two per cent, and the rates at which commercial lenders reward depositors and lend to borrowers is neither simple nor fixed. A bank's cost of funds is a function partly of advertised deposit rates but also of interbank rates, which still run well above Bank Rate, and a "cost of capital" which for some now includes preference shares paying 12 per cent to the Government.

Sounds complicated? It is - but in basic terms it means that when Bank Rate is cut, banks do not just make identical cuts in deposit and loan rates and carry on as before. Even Nationwide, the most solid and cautious of all our mortgage lenders, chose to pass on only 0.69 per cent of the one per cent cut.

Indeed in many respects, the banks are less guilty of exploiting recession-hit customers than the power-supply companies, who told us energy prices had to rise in line with soaring global energy prices. Now that global prices have collapsed again, they say domestic tariffs have to stay.

Behind each bank's rate decision is a calculation as to whether to keep deposit rates high in order to strengthen their retail deposit base and reduce reliance on wholesale markets. On the lending side, it is no surprise, in the midst of a property slump, that banks are not falling over each other to offer attractive mortgage terms.

Bankers like to talk about "correct pricing of risk", which means that they inevitably try to extract bigger margins and tougher terms on loans when times are hard.

For business borrowers, what matters most is whether banks are still prepared to take on the risk of lending to them at all. For the banks themselves, what matters most is that they are seen to take on and price risk only in the most prudent way, so that their own market standing is restored.

Of course the banks have explained all this to the Government, whose chief negotiator, business minister Lady Vadera, is a former banker herself, so should know it anyway. But ministers would like us to believe that the bankers are merely being bloody-minded and selfish.

What is not being said is that rate cuts are intended by the Bank of England as a broad monetary stimulus for the whole economy and an encouragement to business, not just a short-term sop to variable-rate mortgage borrowers. But they can take several months to work through the system and make a real difference to spending and investment.

And what the Government would also prefer not to be said is how few economists have faith in the Chancellor's recent cut in VAT as a faster-acting fiscal stimulus than rate cuts: consumers have failed to notice any difference at all when so many prices are already discounted.

If, as is likely, neither the rate cuts nor the VAT cut make any visible difference to the state of the economy and the housing market until well into 2009, ministers want us to turn our anger on the banks first and loudest.

The banks are by no means innocent: they deserve some stick for the fact that their default position is to behave more harshly towards customers as times get tougher. But in this case they are being used as a stooge by a Government whose default position is to use any deceit to dodge blame.

* Martin Vander Weyer is editor of Spectator Business.