It may not be 2008 all over again – but this
banking turmoil is not without danger
Richard
Partington
New approach is needed to get UK through looming
credit crunch after failure of recovery from crash
Sun 26 Mar
2023 12.48 BST
Crashing
financial markets, depositors rushing to withdraw their money, and fears over
the next domino to fall. Not since the 2008 financial crisis has the global
banking system appeared so fragile, as the rapid increase in interest rates
used to tackle soaring inflation sends shock waves through the City.
In the
turmoil of the past fortnight, the Swiss government-brokered rescue of Credit
Suisse by UBS and the failure of Silicon Valley Bank has led investors on both
sides of the Atlantic to ask the same question: is this 2008 all over again?
How bad can it get?
The short
answer from banking industry experts is “no”, as they argue that the problems
are limited to a few troubled banks. Major lenders are in a much healthier
position than 15 years ago, especially in the UK, after a steady ratcheting up
of bank capital and liquidity requirements. This is not the opening scene of
the Big Short. SVB is not Northern Rock for the Instagram generation.
The Bank of
England reckons the UK system is safe and sound. The biggest lenders have core
capital ratios – a key measure of financial strength – three times higher than
before 2008, while annual stress tests suggest banks could weather an economic
storm twice as strong as the last big crash.
The longer
answer is more worrying. This might not be a carbon-copy repeat of the 2008
collapse, but it is not entirely without danger.
Across the
City, risk managers are scrambling to look again at the health of the financial
firms they do business with. Who might be the next casualty? Are there risks
outside of the banks? How will regulators respond?
Given this
fear, uncertainty and doubt, bank shares and bonds have sold off sharply,
driving up the cost of funding even for supposedly strong and stable lenders.
The big worry is that a higher cost of funding for banks will be passed on to
households and businesses, should the turbulence lead their risk managers to
respond with caution when making new lending decisions.
In other
words: a credit crunch is coming.
After the
most aggressive tightening cycle for interest rates in decades, higher
borrowing costs are beginning to bite hard on the real economy. With an added
layer of financial sector instability on top, households and businesses are
likely to experience a further increase in the cost of credit.
“You have
financial stability issues – even if they’re not really to do with the UK this
time. And in general, it will make people more nervous,” says Alastair Ryan, a
banking industry analyst at Bank of America. “It increases the risk of US
recession, and raises the cost of investment through the bond market and
through the banks.”
The
situation is most pronounced in the US, where there are concerns over cracks
emerging in the $5.6tn (£4.6tn) commercial property market. Jerome Powell, the
chair of the US Federal Reserve, warned last week that banking sector
turbulence was “likely to result in tighter credit conditions for households
and businesses, which would in turn affect economic outcomes”.
A “systemic
credit event” has now replaced inflation as the biggest concern in financial
markets, according to Bank of America’s closely watched monthly survey of fund
managers. And with good reason: Goldman Sachs analysts forecast hawkish
monetary policy and banking stress could cost the world’s 10 leading economies
about 0.6 percentage points of gross domestic product this year.
In the UK,
all of this will badly undermine hopes for a stronger economic future fuelled
by a revival in business investment. It’s a risk the Bank of England is alive
to, saying last week it would watch carefully for any spillovers from banking
industry stress to household and business borrowing costs.
Britain,
after all, enters the looming credit crunch without having ever really
recovered from the last. For many, living standards have not advanced much
since the collapse of Lehman Brothers. Average wages, after taking into account
inflation, are no higher today than in 2007.
The UK was
a perennial underperformer long before 2008, but has stumbled further behind
since – exacerbated by the Brexit vote, Covid-19, political infighting and a
chop-change approach to policymaking.
“You’ve
wasted a decade,” says David Blanchflower, a former member of the Bank’s
rate-setting monetary policy committee during the 2008 financial crash. He
warns that Threadneedle Street will soon be forced to cut rates to avoid a
damaging recession.
“You had an
opportunity for huge public investment at low rates. Which could’ve had high
return, could’ve crowded in private sector investment. But there was none of
that. It all falls at the door of the Tories and their failed austerity.”
The
chancellor Jeremy Hunt’s budget this month included a focus on rebooting
business investment, with tax incentives for company spending. At the margin, there
were measures that might help. But high borrowing costs and banks taking a
tougher approach to lending will push in the opposite direction.
Despite the
painful lessons of 2008, Hunt plans to complement his growth plans by rolling
back some of the banking sector changes put in place over the past 15 years to
prevent another such mess from taking place again. But the “Edinburgh reforms”
could not come at a worse moment.
“There is
no real case for financial sector deregulation,” says Dr Josh Ryan-Collins, an
associate professor in economics and finance at the Institute for Innovation
and Public Purpose, University College London. He says the priority should be
making banks safer, while using the power of the state to direct credit to more
productive sectors of the economy. “It’s a case of ferocious lobbying by
certain interests in the City. And Jeremy Hunt and Rishi Sunak looking for some
sort of growth post-Brexit. But it’s not going to work.”
Instead, an
approach to see Britain through the crunch is required.
In a
riskier world, the government could increase the use of public sources of
capital to encourage a crowding in of private enterprise, with an industrial
strategy to inform the overall direction of travel.
The failure
of the recovery from the last crash would suggest a change in tack is required.
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