Hamish McRae: Banks may take many years to recover, but the City is still pulling in the cash

Economic View

The banks are not yet through the crisis by any means as the losses at Royal Bank of Scotland and the need for more capital for many of the big US banks shows.

And as some of us have banged on about, Britain's fiscal position is a catastrophe that has yet to be fully recognised. However, as far as the financial services industry is concerned, we can now start to think past the crisis to what lies beyond.

This matters a lot to all of us. It matters as taxpayers for two main reasons. First, the better the price that the authorities can extract for their shareholdings in the Royal Bank of Scotland, Lloyds/HBOS, Northern Rock and so on, the lower the direct cost of the rescues. Second, and more importantly, the faster the financial services industry recovers the faster tax revenues will recover and the stronger their contribution to the balance of payments and employment more generally.

On the first, you can begin to see a timeline. Take RBS. We were warned by its chief executive that there would be a further two difficult years. That must be right. A huge wodge of the bank's bad debts are associated with the US sub-prime mortgage disaster, courtesy of its American subsidiary. Until house prices there reach a floor it is hard to see how bad the bank's book really is. You can do theoretical stress tests but what you need to know is how much debt will ultimately be paid back. It will be another three or four years before we have a decent feeling for that.

In any case, you wouldn't want to try to sell RBS back to the market until the market is prepared to buy the shares. That will be four or five years away. You have to wait for share markets generally to make a solid recovery, something much more solid than the, albeit welcome, bounce of recent weeks. You have to wait for bank shares to come back into fashion. And since there are several blocks of shares that will have to be fed back into the market, the sales will have to be staggered over years rather than offloaded in one fell swoop. Still, it is plausible that a start can be made in the next Parliament and the process completed within the next decade.

The recovery of financial services in general will happen more quickly. Here, let's start with some surprising and encouraging news. The figures for the foreign earnings from financial services last year are starting to come through. In 2007, the trade surplus on financial services was £35.6bn and adjustments increased the total net exports to £38.8bn. We have only a few numbers for 2008 but the surplus seem to have risen to £43.3bn. When the full figures come out it may be more.

So last year, despite the banking catastrophe, the City earned a record amount of foreign exchange for Britain. How many people know that? As far as I can see it has been completely unreported. I did not know until I looked up the figures. Foreign earnings have done well through the boom; what I find astounding is that they have continued to rise through the slump.

Why? For a start, banking is only one part of the industry. The sector also includes insurance, shipping finance, securities trading, portfolio management, legal and other services and so on. While we don't have a breakdown of the numbers, we do have figures for insurance earnings last year and those was up from £4.5bn to £4.9bn. It would be reasonable to expect that some other sectors, such as shipping finance, also did well, though, with the collapse of shipping rates in the second half, will do much worse this year.

The rest of the explanation may lie in exchange rate movements. The fall of sterling increases the sterling number for foreign currency portfolio returns and earnings from foreign direct investment. But we will know more when the full numbers are available.

What should we conclude from all this? The first point to remember is just how important financial services are to the UK. You can see the importance of foreign bank lending relative to other countries in the pie chart. The UK has similar dominance in several other sectors of international business, including foreign exchange trading, over-the-counter derivative trading, marine insurance and secondary trading in international bonds. New York leads in some other sectors, such as hedge funds and foreign equity trading, for these two great centres are pretty much neck-and-neck.

The second point to note is that even if banking has a few down years, as I expect it will, companies and indeed governments will continue to need finance. How is our Government going to raise all those hundreds of billions? It goes to the City. There's no other place to go. That is domestic business rather than international, except in the sense that a fair amount of the money the Government is borrowing will have to come from abroad. But wherever it comes from, the City will be busy.

The third point is that the principal driver of international financial services is world trade and investment. Both are having a catastrophic time at the moment. World trade this year will see the sharpest decline since the Second World War. How quickly will that recover? We cannot know the answer to that. We did have a savage decline in international investment after the end of the dot com boom and that was quite quickly reversed so there are grounds for optimism. The International Monetary Fund does predicts a reasonable recovery next year but intuitively I feel that the real recovery will take longer.

Will the UK financial services industry get its share of the business as and when it resumes? I should have thought so. Some will migrate, with Switzerland, Singapore and Dubai important competitors. Dublin will get some if it continues to craft legislation and taxation carefully. But the big battle will continue to be between New York and London. London has tended to gain ground over the past 20 years but may be losing a little market share at the moment. Obviously UK taxation does not now help, whereas it did until two years ago.

By coincidence, the Treasury produced a report last week on the future of financial services, prepared by the grandly titled "Financial Services Global Competitiveness Group", co-chaired by the Chancellor, Alistair Darling, and former a Citigroup chairman, Sir Win Bischoff. I am afraid I found it a bit wishy-washy, not really telling us anything we don't know. The history of the City for the past couple of hundred years is that it has not planned but rather been responsive to market signals. I am pretty sure that this will be the way forward in the future. It is possible, of course, to wreck a financial services business, and some of its former leading lights have done their best to do so. But when anyone sneers at the City that £43.3bn trade surplus is the succinct response.

How office clown David Brent measures children's social understanding

We all know that small children need their parents to speak to them, for it is how they learn to vocalise their thoughts. But some researchers at Sussex University have taken this a stage further. It seems that the way mothers talk to children when they are young can teach them social skills as well as verbal ones.

The research, led by Dr Nicola Yuill and funded by the Economic and Social Research Council, found that children whose mothers often talked to them about people's feelings, beliefs, wants, and intentions, developed better social understanding than those whose mothers did not include much "mental state talk".

What is particularly interesting in this study is that it is "longitudinal" in that it follows the same people, children aged from three to 12 in this case, looking at the way changes happen to them over time. It started with the children at three and looked at how their mothers talked to them when looking at a series of pictures. Then researchers went back when the children were between eight and 12 and showed them clips from a TV comedy, The Office.

Dr Yuill explained why: "Ricky Gervais's character, David Brent, is a typical example of someone who is very insensitive and reads social situations incorrectly. We cringe to watch it." Well, it seems that the children whose mums had talked about emotions started to cringe at earlier ages – or maybe cringed more – than those that hadn't.

This is really interesting research because it helps us understand the process of how humans learn to get along with each other; just the sort of thing we need to know more about.

There was, however, one problem. "The children with the most sophisticated social understanding also exhibited the most negative behaviour towards their mothers when they were steering a model car around a race track – a task where they needed to work together as a team," Dr Yuill said.

I suppose you might sum that up as the cleverest children often being the naughtiest – but I think that fits in with a lot of our experience too.