The credit crunch 10 years on – more regulation, but has anything really changed?
A decade ago, the global banking crisis claimed one of its most high-profile British scalps as Northern Rock spectacularly collapsed as a result of its inability to obtain funding in the interbank debt market to finance its activities, a lack of consumer confidence and a run on savings. It was a watershed moment in a dark period that sparked wide-ranging regulation reforms in the banking sector and held many lessons. But with 10 years of hindsight, have we ensured that it could never happen again?
The problem may be that even reforms introduced with the best intentions have unintended side effects. At its heart is this – since the credit crunch, regulators have required banks to carry much higher capital buffers against risk of loss, intended to ensure much less reliance on interbank funding. This measure has created its own stresses in terms of securing enough investment to meet the requirements, increasing both the cost of capital for banks, and the pressure for investor returns.
"As a consequence, we are seeing a proliferation of consumer investment opportunities such as peer-to-peer lending, alternative investment funds and hedge funds, and the FCA is struggling to keep up with regulating these schemes."
Retail banks do, of course, hold customer deposits, but their operations are usually also supported by borrowing from other banks. This system remains dependent on lenders being prepared to lend, and that depends on their perception of how credit-worthy the borrowing banks are. A lender’s perspective on credit-worthiness is not necessarily the same as that of the regulator – so while capital buffers may have gone some way to move the goalposts, its to a degree, the financial viability of a bank remains tied to the perception of risk and credit-worthiness among potential investors.
The ring-fencing of retail banks is another high-profile measure that may not be as effective as intended. This was intended to ensure that those banks do not engage with the volatile risks of investment banking – limiting themselves instead to a “safer” focus on lending. However, the flip-side is this – by definition, investment banking is higher risk, but it can also bring higher reward. Ring-fencing cuts depositors off from the possibilities of higher returns. With returns on deposits at an all-time low, some depositors will be tempted to look for investments offering higher returns – bringing them back to higher risk.
As a consequence, we are seeing a proliferation of consumer investment opportunities such as peer-to-peer lending, alternative investment funds and hedge funds, and the FCA is struggling to keep up with regulating these schemes. It would be ironic if ring-fencing has put consumers off the banks while driving a growth in higher risk, less regulated schemes. The FCA is anxious to restrict availability to consumers of some of the products they perceive as unsuitable, but prohibition is not an effective way of helping consumers to make informed investment decisions.
Neither ring-fencing nor increased capital requirements have addressed one of the major fallouts of the credit crunch – the availability of credit in the small and medium enterprise (SME) markets. SME lending remains weak, partly because businesses prefer to retain cash rather than borrow, but also due to a reduced appetite for SME lending in the banks. Higher capital requirements and record low base lending rates have meant that banks, in the search for higher margins to placate investors, have tended to focus on larger deals where the economics work better. As a result, businesses either do not invest or borrow in the non-prime markets – an often costly decision.
"Perhaps worst of all, sub-prime debt has not gone away – it’s too lucrative to disappear."
The fallout from PPI mis-selling has been extensive and cost the industry a huge amount of money, as well as lining the pockets of claims management companies. PPI was the most high profile example of banks “bundling” products to increase profitability – a practice which is gradually being outlawed. As banks become deprived of sources of profit, a question is raised about the sustainability of a ring-fenced model of banking in the long term.
In tandem with that goes a tighter leash on traditional forms of consumer credit – again, a measure with a laudable aim that has had some unwanted side effects. Banks may be less likely to lend, or consumers less likely to want to borrow for the reasons cited above – but the appetite for credit has not eased. As a result, we have seen a rise in less palatable forms of credit – high interest credit cards, and expensive payday loans. These loans were originally structured to fall outside the scope of Consumer Credit legislation, so once again regulators are playing catchup with a fast-moving market that shows no sign of losing pace.
Perhaps worst of all, sub-prime debt has not gone away – it’s too lucrative to disappear. Now called "non-prime" it still offers credit to those who can't get it from traditional sources. Property lending percentages are on the rise again – albeit not yet to 2008 levels, but there are top up and guarantee products out there that are enabling borrowers to raise much greater amounts of capital.
So, there has undoubtedly been change through regulation – but has it actually changed anything? Or are these the ingredients for a similar – perhaps worse – credit crunch as we look forward to the next decade? We cannot escape the inevitability that a credit crunch, or something similar, will happen again – it always does. The difficulty is that it will come from a source that no one expects or has planned for. The hope is that the experience of 2007 onwards will make our regulatory and financial systems better able to manage and respond to whatever form it takes.