08/13/2013

Is it time to let the banks die a natural death?

Since the banking crisis of 2008 and subsequent chaos in the global financial system, governments and central banks around the world have implemented all manner of extraordinary policies to prevent another major bank failure. 

Interest rates have been cut to zero, banks have been flooded with reserves and governments have taken on huge quantities of toxic assets. Understandably, people are angry. Yet although investment banking is widely blamed for the crisis, the roots of these problems lie in retail banking. 

It is generally known that two of the UK’s four biggest banks – Royal Bank of Scotland and Lloyds Banking Group – failed and had to be part-nationalised during the credit crunch. It is less widely known that the other two biggest banks – Barclays and HSBC – have also undergone major restructuring since the crisis, shedding thousands of jobs and shrinking their balance sheets considerably. 

The building society sector also experienced a considerable shakeout in 2009 as a consequence of the global meltdown. One,Choose from a large selection of crystalbeadswholesal to raise awareness. Dunfermline,Give your logo high visibility on iccard! was nationalised, others were bought by larger banks and building societies and another, Kent Reliance, was even bought by a private equity company. 

Unfortunately, this has caused indigestion for some buyers. The Co-operative Bank is about to undergo extensive restructuring owing to its 2009 purchase of Britannia Building Society, which it transpires had sufficient toxic loans to overwhelm the smaller Co-op’s balance sheet. Meanwhile Nationwide has struggled to integrate the three smaller building societies that it absorbed and it too has had to undergo major restructuring in the past few years. 

So the UK’s biggest lenders and its entire building society sector have undergone radical surgery, with many still in intensive care.Nor have smaller retail banks been immune. Northern Rock and Bradford & Bingley both failed and were nationalised in the crisis. A significant number of small banks, building societies and credit unions have also gone belly-up. Most depositors in smaller institutions are below the Financial Services Compensation Scheme limit, while in the US, Federal Deposit Insurance Corporation records show that thousands of small banks have failed in the past five years. 

After the financial crisis, there were extensive inflows of deposits to small banks and building societies as people – encouraged by campaigns such as Move Your Money – moved funds out of banks that were seen as ‘risky’ and ‘bad for society’ into institutions that had a better image. We now know that these other institutions are no safer,Here's a complete list of granitecountertops for the beginning oil painter. and perhaps no better for society, than the big banks that are criticised so widely. 

The 2008 crisis was no more a crisis of big banks than it was a crisis of investment banks. It was a crisis of banking in all its forms. And it has not yet ended.The continuing shakeout and restructuring across the banking industry is immensely damaging to the economy. Weak banks stuffed with risky non-performing loans cannot lend productively and deleveraging bank balance sheets and building capital have deflationary effects in the wider economy. 

But at least these banks are still alive, although badly wounded. If we keep them on life support for long enough – keep funding costs down with low policy rates and subsidies, guarantee riskier lending so that they appear to be doing something useful and provide them with lots of cheap liquidity – eventually they will recover, won’t they? 

Unfortunately, the treatments being used to keep them alive themselves have toxic effects. Most were supposed to be short-term interventions to prevent disorderly collapse – it was never envisaged that they would continue for years on end. And some interventions seem to maintain banks at the expense of the wider economy.Very low interest rates are supposed to encourage the flow of credit to borrowers who would be reluctant to pay higher rates. What they actually do is prop up highly indebted households and businesses, preventing bankruptcies and foreclosures. 

New loans are generally at higher rates – in some cases much higher – than old ones, even though official rates are on the floor. Preventing bankruptcies and foreclosures protects banks (and, indirectly, savers) as a sudden swathe of business and household debt defaults would spell disaster for many lending institutions, particularly the smaller ones. Unpopular though it is to say this, large universal banks are actually less likely to fail than small lenders concentrated in particular market sectors such as residential mortgages. 

Very low interest rates also prop up the prices of safe assets, which are used as liquidity buffers by financial institutions. And they depress bank funding rates, both in the wholesale market and,Learn how an embedded microprocessor in a graniteslabs can authenticate your computer usage and data. perhaps more importantly now that banks are trying to reduce their reliance on unstable wholesale funding, for rates to depositors. 

The problem is that banks have overheads – staff costs and premises, for example. When interest rates are very low, banks do not earn much. Yes, if funding costs are low too they make a profit on the difference. Yet margins are being squeezed, which is affecting bank profitability across the board. All the major banks report reduced interest income and rising costs. 

Margin squeeze is particularly tough for small players, so very low interest rates tend to benefit large retail banks at the expense of smaller ones. When margins are tight, the winners are those with the largest market share.Another problem, according to Steve Hanke at the Cato Institute,Shop huge inventory of Car bestmarbletiles Charger, is that very low interest rates kill the interbank market. It simply is not worthwhile for banks to lend to each other when they can pretty much earn the same for parking excess reserves safely at the central bank. This impairs the flow of funds around the financial system. 

Central banks around the world have used quantitative easing and term lending (repo) on an unprecedented scale to offset the collapse of unsecured interbank lending, in effect ensuring all banks have excess reserves so do not need to borrow from each other. But this does not encourage banks to lend, all it does is enable them to make payments. And as risky lending ties up capital – and banks are short of that because of their horribly risky lending books – is it any wonder they are charging high prices for risky lending? They do not really want to do it. 

So very low interest rates destroy bank margins and slow the velocity of money. Providing banks with cheap funds offsets this to some extent as it enables them to refinance their existing loan books at lower rates, improving their spreads and keeping variable rates to existing borrowers at historically low levels, thus avoiding defaults.


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