Why the smaller banks in Britain could be next to face difficulties
Depositors may look to find safer homes if they fear the risk of a broader contagion,
‘It would be foolish to suggest that the UK banks should be totally unaffected by recent events’
Much like viral illnesses, bank runs are often contagious. After Silicon Valley Bank (SVB) collapsed and Credit Suisse reached its humiliating denouement last week, one City banking boss received a phone call from a worried parent.
“My mum called asking whether she should take her money out of the bank,” he says. “She doesn’t have piles of cash in there but the contagion effect filters down and everyone hits panic stations.”
While international markets appeared to cool at one point last week, a surge in investors betting that Deutsche Bank could default on its debts sparked fears that the crisis will rumble on.
Central bankers also compounded issues for the sector when they prioritised the fight against inflation over concerns for the financial sector by raising rates yet again.
Despite the turbulence, Andrew Bailey appeared sanguine. The Governor of the Bank of England derided Janet Yellen’s interventionism, saying US authorities’ blanket guarantee of all SVB deposits increased the risk of “moral hazard” in the industry, as he took a victory lap for orchestrating a quick-fire sale of SVB UK’s arm to HSBC.
So far, UK lenders appear to have been largely immune to the wider crisis engulfing the global banking industry.
But could there be trouble ahead and, if so, where?
Regulations introduced in the wake of the financial crisis mean that Britain’s biggest banks are much better capitalised than they were pre-2008, and Bailey has been at pains to reassure the market that the system remains “safe and sound”.
Gary Greenwood, a banking analyst at Shore Capital, does not think the UK is out of the woods just yet, however.
“It would be foolish to suggest that the UK banks should be totally unaffected by recent events,” he says. “Nervousness in the market has clearly increased.”
Greenwood believes that some smaller lenders, both in the UK and abroad, could be more susceptible to market turbulence than their larger peers.
A notable phenomenon in Britain’s banking industry in recent years has been the rapid growth of upstart digital banks, as London attempted to position itself as a global fintech hub.
Companies such as Starling, Monzo, Revolut, Atom Bank and Zopa have all emerged from nothing to service millions of customers in the space of a few years. There is no suggestion that any of these companies have faced any issues in recent weeks.
“It is possible that depositors may look to find a safer home if they fear broader contagion risk,” notes Greenwood. “This could put some pressure on smaller banks, particularly those funded by instant access deposits or with a high proportion of uninsured deposits, which may be perceived as being at risk in the current climate.”
However, he adds that this is likely to be more of a risk in the US after Donald Trump rolled back parts of the crisis-era Dodd-Frank Act during his time in the White House, loosening regulation on lenders with assets below $250bn (£205bn).
Greenwood says: “It is less likely to be an issue in the UK where smaller banks typically see a high proportion of deposits being government guaranteed or held in term accounts which cannot readily move.”
The cost of capital for these fintech lenders, launched in a period of ultra-low interest rates, has also jumped markedly in the past year after programmes of monetary tightening.
As a precautionary measure after the collapse of SVB, officials at Threadneedle Street ordered lenders both big and small to disclose their exposure to global debt markets as they raced to prevent contagion.
The Daily Telegraph first reported that regulators moved quickly to assess the risk profiles of UK lenders and asked for a breakdown of their investments in bond markets as chaos engulfed Credit Suisse and a string of US banks. Bets on bonds were central to SVB’s collapse. After its investments in long-dated government bonds turned sour after a surge in interest rates, the bank tried to offload some of its portfolio. In doing so, it made a $1.8bn loss on its investment, forcing it to try to raise fresh capital, which spooked depositors who rushed to take their cash out of the bank. The speed at which its tech clients pulled their deposits was unprecedented, highlighting just how quickly a bank run can occur in an age where cash can be moved at the click of a button.
Customers no longer need to form long queues outside branches when they can access their accounts on their phones and laptops. At SVB’s UK arm, nearly £3bn was withdrawn on March 10 alone – a third of its total deposits.
Jonathan Pierce, an analyst at City broker Numis, says: “There is a question of how the authorities prevent a repeat of a crisis once again rooted in deposit flight.”
He adds that funding and liquidity rules introduced post-2008 buy the banks time when deposit outflows begin, “but have proved somewhat ineffective in preventing a subsequent evaporation of confidence”.
For Pierce, regulators should revisit deposit insurance limits. In the UK for example, deposit protection increased to £85,000 from £35,000 pre-financial crisis, but Numis estimates that a third of household savings are still in accounts with balances above that.
While the Bank of England’s intervention to check that UK lenders remained in robust health is understood not to have raised any immediate red flags, turmoil in the global banking industry could hardly have come at a less opportune time for Rishi Sunak and Jeremy Hunt.
It comes just months after the prime minister and chancellor outlined their plan to engineer a “Big Bang 2.0” in the City in an attempt to showcase the benefits of leaving the EU’s regulatory sphere.
Hunt last week confirmed that the Government will push ahead with the so-called Edinburgh reforms, but there are a growing number of voices in the City cautioning against any radical red tape cutting.
One of the headline changes is to relax so-called ring-fencing rules for smaller banks that require them to separate their retail banking services from investment and international banking activities.
Officials would do so by raising the threshold at which the ring-fencing regime applies from £25bn of retail deposits to £35bn. Banks that cross the limit cannot use the funds in their riskier investment bank and trading arms.
Chris Hayward, policy chief at the City of London Corporation, says the Square Mile is a globally attractive financial centre as a result of its robust regulatory regime. Hayward, who last week
outlined plans for a new post-Brexit blueprint for the City to be drawn up, says that the UK should not be focused on a deregulatory drive, adding: “We are not saying let’s have a race to the bottom.” Others are concerned that the recent turmoil in the banking industry could prompt regulators to tighten their grip.
One former chief executive of a City investment bank says: “All the things regulators have made us do since the financial crisis, it begs the question: have they been focused on the wrong things? And will this now lead to more onerous regulation?”
Crises can often give the impression that they have subsided before the situation crystallises. Luke Hickmore, investment director at FTSE 100 money manager abrdn, pointed out last week that one of the lessons from the collapse of Lehman Brothers in 2008 was that markets were very calm in the weeks following its failure.
“I hope things have gone away and it’s calmed down but it feels a bit early to call them all clear,” he said.
But despite concerns, experts still believe that Britain’s large lenders are well positioned to handle any fallout. Numis’ Pierce adds: “Ultimately, the big UK banks are in good shape to weather this storm … Well-run banks should prevail and emerge with greater credibility than before.”
‘All the things regulators have made us do since the financial crisis, it begs a question: have they been focused on the wrong things’