UK Faces Danger of 'Zombie Banks' 

One year since the week that shook UK financial markets, the government is still looking for a solution for the banks in which it now is a shareholder and for ways to kick start the economy and make sure a banking crisis doesn't happen again.

On 13 October, 2008, the British government announced the nationalization of three of the Britain's biggest banks: Royal Bank of Scotland, Lloyds and HBOS.

James Calder

Before then, these institutions had been the pride and joy of Britain – national treasures that contributed towards a huge chunk of gross domestic product, and employed thousands of people. The absolute last resort, a taxpayer funded bailout, was finally undertaken – amidst a grim backdrop of huge losses and palpable instability.

A year later, former Chancellor of the Exchequer Lord Lamont warned that we are in danger of heading towards "zombie banks".

"We are in a situation where there’s been a reduction in trans-national lending, there’s been the disappearance of the shadow banking system and it’s very difficult for banks to fill that hole," Lord Norman Lamont told CNBC on the anniversary of the government bailouts.

  • Watch the CNBC interview with Lord Lamont here >>>

National Investment Bank

One solution would be the establishment of a publicly funded, national investment bank. This type of institution could help kick-start vital lending to small and medium sized enterprises, Lord John Eatwell, member of the Lords Economic Affairs Committee, said.

  • Watch the CNBC interview with Lord Eatwell here >>>

Even in the event of an economic recovery, banks would still not have enough cash to lend out, he warned.

But when will Britain see a recovery in GDP? Lord Lamont said he was very skeptical about the recovery story at the moment, and warned a return to growth won’t come in the third quarter, as many have predicted.

“I think it will be a minus. But after that, even if it is positive, I suspect we will have very weak growth…. I think, not necessarily that we will have a leg down, but that we are going to be bumping along the bottom, with occasional negative quarters for quite some time. Possibly even a few years,” Lord Lamont said.

Current policymakers at the central bank will be focusing on the danger of false dawns, and will be slow to tighten policy, former Deputy Governor of the Bank of England, Sir John Gieve, said, agreeing with the weak growth idea.

Increased Quantitative Easing?

The current quantitative easing program should be increased further, because the Bank should focus on the downside risks to inflation, according to Gieve, but his view is disputed.

"I don’t think you can go on expanding the Bank of England’s balance sheet with money it hasn’t got," Lord Lamont said.

Changing the way banking supervision is done is another solution advanced by various parties, but it, too, has given way to debate.

The UK’s opposition Conservative Party has called for the scrapping of the financial watchdog – the Financial Services Authority – and instead wants to hand regulatory power to the Bank of England.

The tripartite system of financial regulation – made up of the Treasury, Bank of England, and the FSA – doesn't work, Lord Lamont concurs.

But Treasury Select Committee Chairman John McFall argued against a wholesale change in regulation. Instead, he told CNBC that he blames a breakdown in communication between the three and said this is a mistake that could easily be remedied in the future.

"One solution the Treasury Select Committee advocated was the establishment of a Deputy Governor of the bank of England, with a foot in both the Bank of England and the FSA," McFall said.