Banking turmoil: How worried should we be in Britain?
How worried should we be about the banks?
It’s a question that’s been hanging over the financial system since the collapse in the space of a fortnight of three moderate American banks, including Silicon Valley Bank (SVB), followed by Swiss behemoth Credit Suisse.
The spectacle of regulators, political leaders and bankers spending sleepless weekends managing insolvencies, bailouts and takeovers, against the red-ink backdrop of lurching markets, has stirred memories of 2008 and the financial crash.
The answer from Bank of England governor Andrew Bailey, repeated to MPs on the Treasury Select Committee on Tuesday, is “don’t panic”, not yet anyway.
Mr Bailey conceded that recent events made this a moment of “heightened tension and alertness”, but that comparisons with 2008 are erroneous and, so far, UK regulations introduced post-crash are passing the test.
His diagnosis is that while the issues that brought down SVB and Credit Suisse are distinct and separate, the interconnectedness of the financial system means the risk of contagion cannot be ignored.
SVB collapsed because of poor risk management, with deposits locked into fixed incomes investments that fell in value as interest rates rose. Credit Suisse meanwhile, after a decade of unerringly finding new scandals in which to become embroiled, finally stepped on a rake it could not recover from.
Mr Bailey found himself directly involved with the fallout from SVB, engineering the sale of its UK subsidiary to HSBC over a long weekend, with the deal only confirmed he said at 4am on the Monday, hours before markets reopened.
The actions taken by the Bank he said proved the value of new regulation.
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A five-point guide to the banking panic of 2023
SVB had a distinct UK presence because its British branch had grown to a point it was required to become a separate subsidiary. That in turn gave the Bank of England and the Prudential Regulation Authority options in managing its decline, one of which was a sale.
Mr Bailey and his colleagues did concede there are lessons to learn, primarily from the speed with which confidence and, crucially, deposits were withdrawn from the banks.
As a result they will re-examine whether the current bank “stress tests” governing liquidity – the amount of cash banks must have on hand to absorb shocks to the system – are adequate.
Technology may have helped change that calculation. In 2007 we knew Northern Rock was on the brink because customers were queuing outside branches. Today you can withdraw funds digitally in the time it takes to read this sentence, and a bank run could be underway by the end of the paragraph.
Deputy governor Dave Ramsden told MPs that messaging apps further accelerate the potential for bank runs, and said this was a factor in the SVB collapse, with the bulk of depositors all working in the tight-knit US tech industry.
“They were a tech-savvy group, already using messaging in ordinary situations, using it in a run situation.”
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The result was what Bailey called “the fastest journey from health to death since Barings”, a reference to the British investment bank that collapsed spectacularly in 1995.
But he insisted the issues are bank-specific and isolated, describing the jitters that have seen banks stocks rise and fall rapidly as markets “testing” various institutions, looking for weakness. The latest example came on Friday afternoon, when Deutsche Bank’s valuation fell without an obvious trigger only to recover on Monday.
“My very strong view of the UK banking system is that it is in a very strong position,” Bailey said. “But there are moves in markets to test out firms, they are not based on identified weakness, rather they’re testing out. There’s a lot of testing going on.”
The Bank of England has cut interest rates from 4% to 3.75%, its sixth cut since last summer.
The decision follows a bigger-than-expected fall in the consumer price index rate of inflation in data released this week. While inflation is still above the Bank‘s 2% target, the fall to 3.2% helped swing today’s decision, with five of the Bank’s nine-member monetary policy committee (MPC) voting for a cut.
The governor, Andrew Bailey, who had voted to leave rates on hold in November pending more data on inflation, shifted his vote this time around.
Money latest: What interest rate decision means for you
“We’ve passed the recent peak in inflation and it has continued to fall,” he said, “so we have cut interest rates for the sixth time, to 3.75 per cent, today. We still think rates are on a gradual path downward. But with every cut we make, how much further we go becomes a closer call.”
The decision will mean those with floating rate mortgages should immediately see a reduction in their monthly repayments – and some lenders are now reducing fixed-rate deals to 3.5% or below.
The Bank also gave its first full assessment of the economic impact of last month’s budget. It said the budget, which included measures to reduce energy bills and freeze fuel duty, should help push inflation half a percentage point lower next year.
That would mean CPI inflation would drop to close to the Bank’s 2% target as soon as the second quarter of 2026, nearly a year earlier than it originally expected.
However, the Bank also warned that growth remained weak. It said it expected gross domestic product to flatline in the fourth quarter of the year.
Since the decision was a narrow one, with four members of the MPC voting against the cut, some investors might judge that the Bank remains finely balanced on future decisions. Right now investors expect another cut by the end of next spring and, possibly, another one thereafter.
But whether rates eventually settle at 3.5% or 3.25% – or even lower – remains a matter of debate.
The economy may be stuttering, unemployment may be rising, inflation may be above target. But even so, the Bank of England delivered mortgage payers some welcome Christmas cheer on Thursday.
The quarter percentage point cut in interest rates was far from a surprise – the vast majority of economists and investors had expected the Bank to cut rates down from 4% to 3.75%. But even so, for those still struggling with the cost of living, the decision will help lighten the load through the winter months.
And, if the pricing in financial markets is anything to go by, there will be more cuts to come next year with one or maybe two more cuts priced in by investors.
Money latest: What interest rate decision means for you
There was Christmas cheer, too, for the chancellor, as the Bank revealed that it expected the measures in her budget to reduce inflation by half a percentage point next year, thanks largely to her measures to reduce energy bills and freeze fuel duty.
This is a hefty reduction – and means that far from having to wait until 2027 to see inflation come down to its 2% target, the Bank thinks the target will be hit as soon as next year. In short, the Bank has offered its seal of approval to Rachel Reeves, who said repeatedly that she was hoping to craft a non-inflationary budget.
However, deeper questions still remain. To what extent is Britain’s low inflation a good news story – the fruit of clever monetary and fiscal policy – or something else? For there are some who worry that instead it bears all the hallmarks of economic slowdown. The slower the economy is growing, the less people spend and the lower inflation goes. And the Bank said it expected economic growth to drop to zero in the final quarter of the year.
There are also suspicions inside the Bank that one of the consequences of Donald Trump’s trade war is that cheap imports from China, that would previously have flowed into the US, might be diverted to Europe. That would, on the one hand, push down consumer prices. However, it also risks pushing European manufacturers into the red as they struggle to compete.
On the other hand, there’s a deeper worry that, having experienced high inflation for quite a few years, consumers are now so used to it that they might “bake” higher inflation into their personal mental maps. That could, in turn, mean they push for bigger annual wage increases, which in turn pushes inflation even higher. In short, the question as to whether the inflation genie is still out of the bottle remains.
Finally, there’s the question about whether the trade war is a signal of something bigger: the end of the decades-long period of uber-globalisation. If it becomes more expensive to transport goods around the world, that implies that everything could gradually become more expensive.
Still, for the time being, the Bank has delivered its last piece of analysis and policymaking before the end of the year. And, for the most part, it’s a set of measures and analysis that most people will be cheered by.
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