Catastrophe? No, a wake-up call
By Hamish McRae email@example.com
dmg media (UK)
THIS is big, but it is not a catastrophe. Indeed the banking crisis that rocked the world last week may turn out to be just the thing to knock some sense into the industry and the people who regulate it. Warren Buffett, the legendary US investment guru, famously observed in his 2001 Berkshire Hathaway Chairman’s Letter: ‘You only find out who is swimming naked when the tide goes out.’ Well, the tide went out when the 2000 dotcom bubble popped, and with the 2008-9 banking crash. Now it has gone out again. At some stage interest rates were always going to return to normal levels, and as we saw last September, some pension funds were stupid enough not to plan for that. Now it is the turn of the banking industry, as we report opposite, and the lesson here is that a run on a medium-sized enterprise called Silicon Valley Bank was enough to trigger a global crisis. The UK authorities have handled this well, with HSBC rescuing the London end. But history tells us it will be some time before all the weak banks around the world are rescued – or allowed to go under. We cannot see the detail, but we can, I think, see some immediate lessons, some longer-term ones, and a possible opportunity. The immediate lessons are obvious. First, there will have to be changes in regulation, with banks having to carry larger reserves and a greater proportion of those reserves in the form of cash. That puts up the cost of capital and may reduce the availability of loans. But that is the price that has to be paid for a safer banking system. Next, interest rates worldwide will not have to rise as much as markets predicted, indeed maybe not much further at all. This is not because the central banks have got frightened or gone soft on inflation, though they should be chastened by what has happened. Rather it is because we don’t need higher rates so much. The loss of confidence, and the fact that banks will be more cautious in their lending, will do the job of damping down economic activity in much the same way as yet higher interest rates would have done. Third, there will probably be some hit to global growth. I see the OECD has come up with some glum forecasts about UK prospects but I would not pay much attention to them. We are in a world where all predictions are being swept aside by events. A lot of wealth has been destroyed by the crash in share prices around the world, and not just in the banking sector. It is impossible to quantify how this will slow global growth but it cannot be positive. Intuitively, I expect the UK to come through this year in relatively good shape. Beyond these immediate lessons are some more nebulous themes. For a start, there will be a shift of mood in banking. There should still be funding for viable projects, but it is going to be harder to get bank finance. We have learned that even medium-sized banks can be systemic, in that it can trigger a global crash of confidence. So all banks will have to be clear that it is their first duty to protect their depositors’ money. Better boring than bust. Next, this shift to normal interest rates is something that we have to get used to and will have other consequences than putting pressure on badly-run financial institutions. If there is to be a long period when interest rates are higher than inflation, that will change attitudes to money more generally. It will be a climate of caution that will run through the corporate world, as well as the financial one. Companies will be punished for being highly-geared. So a welcome return to common sense: debt has to be secured, while equity funds risk. Third, there will be a real problem getting finance for highgrowth, or at least high-potential, enterprises. There is the longstanding problem of the gap between small-scale businesses that can rely on ‘friends and family’ for finance, and those that can float. But that gap seems likely to widen, and it would be worrying if viable ventures get knocked on the head for lack of capital. That leads to the opportunity. There are many investors who want to take on risk and play a role in supporting entrepreneurs. There are longstanding tax incentives to do just that, including Venture Capital Trusts and Enterprise Investment Schemes, but to generalise, costs have been high and results have not been stellar. That is the challenge for UK financial institutions: find more effective low-cost ways of matching the money with the enterprise.