Banks ready to fund a thriving economy
The global financial crisis 10 years ago was caused by the collapse in the value of US homes, and so in the value of US mortgage debt, globally circulated, that had funded a long boom in US house prices.
By 2012 the average US home had lost 32% of its July 2006 peak value. US mortgages, however sliced and diced, lost much of their value. Much of the capital of highly leveraged banks was wiped out.
Average house prices are now slightly ahead of their peak valuations of 2006. The value of the average US bank share fell 83% between its peak of 2006 and its trough of 2009, but has risen by nearly four times.
The crisis for US banks is long over thanks to bold, unprecedented interventions by the Federal Reserve, which pumped extraordinary amounts of cash and equity capital, supplied by the treasury, into the banking system.
Much of the extra cash supplied to the banks by their central banks through open market purchases of bond and other assets, known as quantitative easing, ended up permanently on the asset side of bank balance sheets as extra cash held with central banks rather than used to fund additional loans, as would have been normal.
SA banks were not directly exposed to the US mortgage market. This was because SA banks in the boom years of 2003-2008 could gorge themselves on the local demand for mortgage credit arising from a booming housing market. At the peak in 2006, the mortgage books of SA had grown 30% over the previous year. House prices had grown by an average of 14% per annum between 2000 and 2008. They continued to rise very modestly after the financial crisis (rather than fall), enough to protect the value of mortgage debt.
The Reserve Bank therefore did not have to practise quantitative easing. The cash reserves held by SA banks, as normal, were held almost entirely to satisfy required reserve ratios set by the Bank. SA’s banks continued to borrow extra cash from the Bank after the crisis, as is also normal in SA.
Short-term interest rates in SA were very helpfully allowed to fall rapidly after the global financial crisis as the rand recovered and inflation receded in 2010. However, they increased in 2014 despite the persistent slowdown in GDP growth after 2012, to which higher interest rates unnecessarily contributed. The decline to sub-2% GDP growth rates occurred only after 2014, accompanied inevitably by very slow growth in the money supply and bank credit.
Supporting the boom of 2003-2008 were much improved mining and export prices, as well as more valuable homes. A short-lived economic recovery after the recession of 2009 was accompanied by the revival of the commodity supercycle. Alas, for SA, this ended in 2012 and drove the rand weaker and inflation higher.
The hope is always that a recovery in metal prices will lead to a stronger rand, less inflation and lower interest rates to stimulate a recovery in GDP and credit growth. SA banks cannot flourish without a strong economy, and the economy cannot flourish without strong growth in the real supply of money and credit.
There is no reason to think SA banks would not be up to the task of funding a much stronger economy should the opportunity present itself. Lower interest rates and increased demands for and supplies of bank credit are necessary for the purpose, as are policy reforms that would reduce the SA-specific risks banks and their borrowers are required to take.