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.