Clearly tensions are building between political objectives; lend money to SMEs, create jobs, generate greater tax revenues, address deficits and get the nascent recovery to escape velocity.

On the other hand, regulators' objectives are focused on grappling with too big to fail, and making banking 'safer' through Basel and Dodd Frank. They are focused on de-risking large financial institutions by calling for more bank capital.

This binary conversation or should it be shouting match doesn't do justice to the subject.  A couple of  charts produced by McKinsey as part of their work on sustainable banking (registration needed) summarise the problem quite well.

In a low margin environment accompanied by the loss of some services such as structured products profitability has been hit hard.

Return on Equity has dropped dramatically, so profits are not being earned which could potentially provide a base for increasing capital through profit retention. Given the poor profit outlook, going to the market to raise fresh capital hasn't been too appealing either, with some banks seeking support from sovereign investors instead.

If increased capital is a regulatory requirement then banks will build capital, because politicians can rail at them, but regulators can fine them or put them out of business.

If capital  is defined as that  part of a banks cash that isn't borrowed, in the absence of options to increase capital, you borrow less so the capital base increases as a proportion of risk assets. Not lending or running down lending books means loans can be repaid and the underlying capital base should increase as a proportion of assets. However, revenue drops so profit will be affected in time.

De Facto banking is shrinking!

 

Capital doesn't have to be held in some special pot, unlike say liquidity buffers that are held in gilts and can't easily be lent out. If we accept that capital is the value in the bank not sourced from borrowing it could be lent out, but that would slow the rate of capital improvement as a ratio, as the lending book grew.

Of course having safer banks is an objective many people would agree with, but there is a cost in lower returns and the need for higher capital. This is especially difficult to achieve where it has to be generated from modest profits in a low slow growth environment.

Shouting at banks has become the norm, shouting at regulators too may make the politicians feel a bit better, but it won't make much difference to lending.