U.K.’s O’Donnell Says Banks Need to Shrink Their Balance Sheets

Gus O’Donnell, the former head of the U.K. civil service, said banks may have to cut lending to make them less risky and reduce their threats to the economy.

“It’s a big mistake to think of this as a normal recession,” O’Donnell, one of the front-runners to succeed Mervyn King as Bank of England governor, said in an interview with Understanding Society magazine published July 11. “At the heart of it is the financial crash - the banks got too big, leverage was too high.”

O’Donnell’s comments were made as the central bank introduced a new push to boost credit for companies and households. The Funding for Lending Scheme, designed with the U.K. Treasury, aims to provide banks with cheaper access to funding. First announced in June, the program began yesterday and lenders have 18 months to tap the facility.

“We have to end up with a world where the banking sector will be smaller as a share of our GDP and the leverage will be much, much lower and they’ll have a lot more capital,” O’Donnell said. “Part of the way for them to do that is by contracting their balance sheets, which means, without the jargon, less lending.”

O’Donnell also said that a lot of large companies have stockpiles of cash that they “do not know what to do with.”

“We need them to invest directly,” he said. “In 10 years time the role of banks in corporate lending could be much smaller. In addition, we will have a lot more direct lending from individuals to small and medium enterprises.”

He added that it will be a “slow recovery” and the U.K. needs to “diversify our exports away from the euro area.”

O’Donnell is the favorite to become the next Bank of England governor, according to odds at bookmaker Paddy Power Plc. (PAP) He is at 9-4, meaning a 4-pound winning bet would return a 9-pound profit. Deputy Governor Paul Tucker is 5-2 at the bookmaker.

To contact the reporter on this story: Scott Hamilton in London at shamilton8@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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