Disaster? No, a wake-up call, says HAMISH MCRAE: The banking crisis may be the right thing to do to make sense of the industry and the people who regulate it
It’s huge, but it’s not a disaster. Indeed, the banking crisis that rocked the world last week may turn out to be just the thing to bring some sense back to the industry and the people who regulate it.
Warren Buffett, the legendary American investment guru, observed in his letter from the chairman of Berkshire Hathaway in 2001: “You only find out who’s swimming naked when the tide goes out.”
Well, the tide died down when the dotcom bubble of 2000 burst and with the banking crash of 2008-2009. Now it is off again.
At some point, interest rates were always going to return to normal levels and, as we saw last September, some pension funds were foolish enough not to anticipate this.
Now it’s the turn of the banking sector and the lesson here is that a run on a mid-sized company called Silicon Valley Bank was enough to trigger a global crisis.
Cracking up: A run on a midsize company called Silicon Valley Bank was enough to trigger a global crisis
The UK authorities handled the situation well, with HSBC saving the London side. But history tells us that it will be some time before all the weak banks in the world are saved – or allowed to fail. We can’t see the specifics, but we can, I think, see some immediate lessons, some longer-term ones, and possible opportunity.
The immediate lessons are obvious. First, there will need to be regulatory changes, with banks having to have larger reserves and a larger proportion of those reserves in the form of cash. This increases the cost of capital and can reduce the availability of loans. But this is the price to pay for a safer banking system.
Then, interest rates around the world won’t have to rise as much as markets had expected, or perhaps not much more at all. It’s not because central banks got scared or softened inflation, although they should be punished for what happened.
Rather, it is because we do not need higher rates so much. The loss of confidence and the fact that banks will be more cautious in their lending will have the effect of dampening economic activity in the same way that even higher interest rates would have done.
Third, global growth is likely to be somewhat affected. I see the OECD has made gloomy predictions about the UK’s outlook, but I wouldn’t pay much attention to that. We are in a world where all forecasts are swept away by events.
A lot of wealth has been destroyed by falling stock prices around the world, and not just in the banking sector. It’s impossible to quantify how this will slow global growth, but it can’t be positive. Intuitively, I expect the UK to come out this year in relatively good shape.
Beyond these immediate lessons, there are more nebulous themes. For starters, there will be a change of mood in the banking sector. There should still be financing for viable projects, but it will be more difficult to obtain bank financing. We have learned that even mid-sized banks can be systemic, in that they can trigger a global collapse in confidence. All banks will therefore have to be clear that it is their first duty to protect their depositors’ money. Better to be bored than to bust.
Then, this return to normal interest rates is something to get used to and which will have consequences other than pressure on poorly managed financial institutions.
If there is to be a long period where interest rates are higher than inflation, this will change attitudes towards money more generally. It will be a climate of caution that will cross the world of business, as well as that of finance. Companies will be punished for being over-equipped. So a welcome return to common sense: debt must be secured, while equity is at risk.
Third, there will be a real problem obtaining financing for high-growth, or at least high-potential, businesses. There’s the long-standing issue of the divide between small businesses that can rely on “friends and family” for funding and those that can float. But that gap looks likely to widen, and it would be worrying if viable companies were knocked down for lack of capital.
This leads to opportunity. Many investors want to take risks and play a role in supporting entrepreneurs. There have long been tax incentives to do just that, including venture capital trusts and business investment programs, but to generalize the costs have been high and the results haven’t been stellar. That’s the challenge for UK financial institutions: to find more efficient and inexpensive ways to match money with business.