Under the cosh: Declarations that the banking system has been rendered ‘resilient’ look thinner with each passing day, says ALEX BRUMMER
- Banking events are similar to flooding which follows a plumbing failure
- Water finds the weakest point in the pipes and comes pouring through
- Origins of present problem lie with money creation since great financial crisis
There is much about the handling of the eruptions in the banking system that is perplexing.
A crisis that began with Silicon Valley Bank (SVB) in the US was ultimately triggered by the Federal Reserve’s relentless drive to raise interest rates and stymie inflation.
Yet given that the origins of the tumult were the rapid rise of borrowing costs, which drove bond values down, the decision by the Fed and other central banks this week to keep raising rates – when they could have paused or even cut – was perverse.
We saw how quickly changes in the bond markets can affect stability in the UK last year when the flawed Truss-Kwarteng mini-Budget caused mayhem in pension funds.
It threatened to trigger a wave of insolvencies had not the Bank of England intervened. Central bankers gloss over the impact of economic and monetary policy on financial stability at their peril.
High and dry: Banking events are similar to the flooding which follows a plumbing failure. Water finds the weakest point in the pipes and then comes pouring through
Andrew Bailey at the Bank of England and the other central bankers argue that individual countries, by enforcing their own prudential rules, can inoculate domestic banking system from the turbulence. That certainly was true of Canada and Australia in the financial crisis. But these countries do not sit at the core of the financial system. The United States, Switzerland, the eurozone and Britain are in a very different place as home to some of world’s most significant financial institutions.
The same hedge funds and financial players that lost confidence in SVB, Signature, First Republic and US regional banks, taking heavy losses along the way, moved against other vulnerable banks. Credit Suisse first, and in latest trading Deutsche Bank found itself in the line of fire.
Banking events are similar to the flooding which follows a plumbing failure. Water finds the weakest point in the pipes and then comes pouring through.
Deutsche Bank returned to profitability in 2022 after countless quarters of loss making. But the insurance bought to insulate investors against loss – known as credit default swaps – shows past weakness has not flushed through the system. No sooner had Deutsche Bank’s share price wobbled and then dived than other European bank stocks in France (amid political turmoil over pensions) and Italy were shaken.
The effort in the last couple of weeks by central bankers to argue that monetary policy and financial stability can be managed on separate tracks is misleading. The origins of the present problem lie with money creation since the great financial crisis.
It is the reversal of that policy, in the face of rising inflation, which has so confused bond markets.
Christine Lagarde at the European Central Bank, and her cohorts in other central banks, stood by the fiction that raising rates would not fuel the crisis.
As eurozone banks swooned in pre-weekend trading, Lagarde promised more liquidity. Yet it was liquidity, in the shape of quantitative easing and easy money, which was among the factors that provoked the unwinding of bond buying and higher interest rates.
Both the Fed and the Bank of England this week acknowledged that the ripples from banking failures could lead to a tightening of credit conditions.
That has already happened. Bond issues on Wall Street have been stopped in their tracks. A UK borrower, with a risky real estate or tech proposition, is unlikely to be welcomed with open arms. Over the last several weeks there has been a rout of bank share prices, weakening capital. Not only that, but the wipe-out of cocos or AT 1 bonds at Credit Suisse created its own mini-scare about the safety of this capital.
Declarations from Frankfurt, Brussels, Washington and London that the banking system has been rendered ‘resilient’ look thinner with each passing day.
Latest bids for Manchester United have reportedly hit the £6billion mark. That is all terribly exciting. If such a price were achieved, it would value the club in same ball park as 27-times World Series winners, the New York Yankees baseball franchise.
A developing credit crunch could quickly thin out the field of potential buyers as the cost of debt finance rises. Jim Ratcliffe and the other would-be sports tycoons may find it hard to compete with Gulf potentates flush with oil and gas proceeds.
But as Yankee legend Yogi Berra observed, the game ‘ain’t over till it’s over’.