British Prime Minister Gordon Brown on Saturday warned that the global economy is slipping into a dangerous form of financial protectionism that could lead to serious problems for emerging markets that are dependent on lending from foreign banks.
Mr. Brown, attending the annual World Economic Forum, also said in an interview that the U.K. government hasn't ruled out the use of a so-called bad bank if that is what is required to help banks shed souring assets and resume lending to struggling homeowners and companies.
Increasingly, banks hurt by a financial crisis that dates to the fall of 2007 are taking steps to decrease the assets on their balance sheets in an effort to shore up capital. Today, banks are fighting a two-front battle against volatility in the capital markets that can lead to write-downs and against a massive recession sweeping through Western economies.
But steps taken by the banks to reduce their risk -- and by regulators seeking to stabilize banks at home -- are leading to new and unexpected forms of imbalance.
"As large international banks have come under pressure there has been a retreat to domestic home-based banks," Mr. Brown said. "The combined loss of capacity in the world as a result of that is creating real dangers. Eastern Europe is one very good example. But every country is affected by this.".
In the interview Saturday, Mr. Brown said that if the so-called financial protectionism increases, it will spill into the broader economy and negatively impact global trading.
"What you've got then is a form of financial mercantilism," Mr. Brown said. "What you've got is people retreating to their home-based banking systems. It's the first stage of a financial protectionism that will lead eventually to the kind of trade protectionism that we've seen in the past if we are not prepared to do anything about it."
Mr. Brown appears to be setting the stage for the agenda for the April summit in London of the Group of 20 developed and developing economies, saying that the worsening form of trade protectionism was something "the G20 has got to address." "If you're seeing a destruction of capacity in countries that are left vulnerable as a result of it, and your only mechanism for dealing with them is a bailout by the IMF at the last possible moment, than that's really not a good way of operating a system," Mr. Brown said.
Earlier this week, Stephen Green, the chairman of HSBC Holdings PLC, the largest U.K. bank in terms of market value, expressed a similar concern that world trade could suffer if banks ceased lending in emerging markets.
The problem of banks retreating is being felt back home in Britain. Mr. Brown said that Royal Bank of Scotland Group PLC, which received a state bailout and is now majority owned by taxpayers, along with other British banks are stepping up lending and yet there remain significant lending gaps. The U.K. has been hurt by the exit of Irish and Icelandic banks that had been aggressive lenders.
"Because of the loss of capacity in the British banking system because foreign banks have moved out and non-bank investors have also moved out, then you've lost a very significant amount of your capacity," Mr. Brown said. Mr. Brown separately said the U.K. government remains open to other ideas to help the British banks. Earlier this month, the government unveiled a multi-pronged effort to shore up lending including the use of an insurance scheme that would cover bank losses from souring assets. The British government stopped short of setting up a so-called "bad bank" that could be used to allow banks to slough off assets to a separate vehicle. The U.S. is considering a bad bank.
"We have said that we favor looking at a number of different ways of dealing with this," Mr. Brown said. "The protection through insurance but we've also said our scheme is sufficiently flexible to deal with the bad bank-good bank if necessary."
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