I have mixed feelings about Mark Carney’s speech yesterday, when he announced that the Financial Policy Committee would ease banks’ capital requirements, encouraging them to lend.
Relaxing capital requirements to ease funding availability for individuals and SMEs may work. It’s a bit like targeted QE and if we can stabilise sentiment and continue growth with a weaker pound, it may prove a masterstroke.
But I can’t help the nagging feeling that it’s a bit like the morning you wake-up after over-eating and loosen your belt or put on a size larger pair of trousers. You immediately feel comfortable but there is a little voice telling you that it’s not the solution.
So, why not? The Bank of England frequently tell us that our banking system is better capitalised than before the financial crisis and, in the case of the very large banks, that is undoubtedly true.
What about newer, challenger banks though? Despite ongoing lobbying to create a level playing field, many challenger banks – asset class dependent – have similar tier one capital ratios to the behemoths. And yet their portfolios are inevitably less well spread and consequently could be riskier. This is particularly the case in relation to commercial mortgages and risker forms of lending.
I was told recently by a policy maker that a “managed failure” would be good thing and that it would prove the strength of the system. This may be true. Only time will tell and a full economic cycle will be needed to judge, but I wonder whether industry commentators will be so sanguine come the day?
The purpose of a stronger capital ratio is to absorb more losses in a downturn and thereby protect depositors. To loosen capital ratios at a time of potential downturn appears at first blush to have the potential for increasing the risk to depositors.
So, is the risk actually higher? Well, in the market I see most of (SME funding), I have been warning about overheating for some time due to a swath of newer, online lenders flooding the market in recent years.
We are seeing larger cash advances, lower pricing, weakened covenants and weaker security. I’ve warned before that this will end in a bust of sorts. This isn’t to say that some of these online lenders won’t survive and do well, but it’s a good bet that some won’t.
In my view, this was going to happen regardless of the Brexit fall out – it’s a clear case of supply exceeding demand. But will the issue become compounded now the Bank has increased supply? Maybe.
Now we have loosened our belts, the world suddenly looks a little brighter and it seems as though we have room to grow. I guess the worry is that when we expand up to the next notch on the belt, our diet will need to be even more extreme and the correction in SME funding (and lending more broadly) may be even harder on the economy.
It is possible that the Bank have genuinely reinvented the way our economy and its banking system works, but decades of market experience lead me to be cautious.