BANKING STABILITY

5. Empire (Roman)

Money lenders took deposits (providing safe keeping) and lent to others along with their own. Would also transfer such sums between clients (but not between other money lenders or banks). Recognised banking systems in Italian towns.

Banking systems tended to be unstable - relying on people not drawing money out - prone to runs-on-the-bank. Caused quite violent economic cycles. Laws to control - became more orderly - controls on maximum interest rates


6. Medieval (Europe)

Money lenders lending to kings hazardous "no way they can force repayment". Charles II in England: Consolidated Fund made available to secure such loans.

7. Industrial Revolution

Largely repeat of 5. Laws provide for minimum liquid reserves. Laws prevent true banking in England to control instability - Bank of England given monopoly in London - other Bankers can only deal in Bank of England Promissory Notes.

8. Consumer Society

Recognised that Banking systems increases the money supply - Banking Multiplier X6.

9. Mass Production Society

World wide banking collapse traceable to formation of German-Austrian customs union 1931. French Banks withdrew deposits from German and Austrian Banks producing banking failures in Austria, which spread to Germany, then run on Pound and Bank of England - temporary law relieves Bank of obligation to repay its Notes (i.e. UK leaves the Gold Standard and never returns). 1932 crisis crosses Atlantic. US Banks closed and none re-opened until solvency proved - 5,000 US Banks went bust. Contraction of Money Supply cause of the Depression.

All money becomes debt of nation states between 1930 -70.

10. Post Industrial Society

Growth of foreign deposits in the two main Banking Countries (US & UK). Banks have difficulty in finding traditional secure credit markets to deploy these funds. They move to lending to governments, especially MRCs, LDCs, and UDCs, without the traditional banking security. Competition in such lending becomes severe. View was that governments cannot go bankrupt. The Sovereign loans. Many such governments found themselves over extended and could not repay capital and interest. Banks "found no way they could force repayment". The Banking Crisis from 1982.


BANKING STABILITY - CONSTANT TRENDS

The main Constant Trend is that banking is inherently unstable. There is a similar Constant Trend in Savings - that whenever there is a new development it is likely to be inherently misconceived - and social learning is necessary before such developments gain some stability.

The banking systems forms a system of interlocking debt. Most of any new deposit is lent out as new loans - much of which appears as new deposits in other banks (or other branches of the same bank) - most of which is lent out again as new deposits - and so on repeatedly. Hence the money supply is increased considerably by a banking system - the multiplier generally calculated is 6. Clearly such a system is inherently unstable - if parts of it collapsed the whole can collapse like a pack of cards. Solvency laws and practice with respect to security for loans helps to raise the threshold of instability. But then the system relies on stability in the external environment - but this is seldom stable for long periods. A jolt always has the risk of producing banking instability.

It is worth considering a model of collapse, based largely on the 1931 Banking collapse. The starting point might be a jolt in the external environment - perhaps not recognised as being connected with the banks or the subsequent collapse. There was the 1929 Stock Market collapse, producing large falls in the money supply. The start of the collapse may be the innocent withdrawals by French banks from German & Austrian (see previous Historical Analysis) - a jolt. Or in other circumstances it may start by the inability of borrowers to repay - the 1980s Banking Crisis. But one leads to the other in the following sequence:

Thus vicious circle builds up, each step to rebuild reserves causes more reserves needed to be built up - and the crisis spreads to other banks, and to other regions of the world.

As the crisis spreads to most banks they are able to re-build reserves by raising interest rates together:

At this stage the sale of assets of the banks, their borrowers, and the bankruptcy trustees causes assets values generally to fall, producing a lowering of inflation from what it would otherwise have been.

Thus the symptoms of low inflation, very high (real) interest rates, and very high business failures indicate a spread of a banking crisis in a region or the world (1932).

There will be a trickle of banking failures - and the next stage is for this trickle to grow. This growing banking failures causes a new factor - loss of confidence in the banks of that region - depositors move to withdraw their deposits - a run on the banks starts which no bank can survive. They must shut their doors.

When this stage is perceived governments have always stepped in. Their action has been to attempt to freeze or hold the situation - using their ability to print money if necessary. The institutions in the system can then be investigated, the hopeless put into liquidation, the stronger encouraged to help the weaker, then gradually the system can be allowed to start operating again. It works because people's right to withdraw their money is taken away from them. Governments concern seems to be to preserve the banking system - and do little to help ordinary people denied access to their money by the forced closure of their bank for an extended period, and forced into bankruptcy by this (Roosevelt 1932).


BANKING STABILITY - IMPACTED SCENARIO

The Constant Trends and obvious impacts indicate that the early Post Industrial period will not be one of Banking stability. Banking systems being inherently unstable, and rely on a stable environment - which they won't get since the financial environment will be turbulent (from Business Cycles, Inflation, Savings). The large swings in economic variables can be expected to provide jolts in otherwise sound systems triggering instability in unforeseen ways.

Banking Crisis

However at the start of the period, the Banking system is not sound. It has been embarking on a huge new development - overseas deposits and loans - which true to the Constant Trend has proved misconcieved - in its Sovereign loans. Further more the Constant Trend from Credit is that loans to rulers is always hazardous.

This Banking Crisis was privately given evens chance by economists of resulting a major banking collapse, and evens of muddling through. The classic features of a banking collapse could be traced through the 1980s and 1990s as deduced under Constant Trends:

The following account of the unfolding of this Sovereign Loans Banking Crisis is maintained, but before it worked itself out it was superseded by another Banking Crisis, the Credit Crunch. It is forgotten nowadays that we may still be suffering from this earlier Banking Crisis, and it is instructive to follow its course into the current Banking Crisis, which is given in Italics.

At the time of writing the banks' bad loan provisions have declined. It looks as if the muddling through scenario will occur. As in previous Banking Crisis the Banks themselves - who caused the crisis through their misconceived Sovereign loans - for the most part have survived - it is their unfortunate advanced world customers who have paid the price - along with other financial institutions and their customers who have got caught up in the inevitable spread of the crisis.

Of the other symptoms of this Banking Crisis:

This implies that the passing of this Banking Crisis will see the return of higher Inflation - the causes of which have not been removed since the 1980s - only masked (see Inflation). The rise in Money Supply should be monitored. Both US and UK have returned to government deficits - which is regarded a prime cause of inflation.

There are some other factors resulting from this Banking Crisis which impact on other Areas generally:

  1. The Banks' Sovereign losses, the bankrupting of their customers in the advanced world, the contraction of the money supply, can be expected to have depresses world economic growth. This can be seen in OECD data from the Boom in the early 1980s to the depression in the early 1990s. With the Crisis working itself out this should raise economic growth - which perhaps is apparent in the data from mid 1990s. Individual countries are more variable, and the Banking Crisis may not be the only factor operating. It is considered that the fall of the USSR, which has caused economic contraction in this region, and has depressed growth in the advanced world from various impacts. The passing of the Banking Crisis should result in an uplift to world economic growth.

  2. Some economist have reckoned that the Banking Crisis has caused a demand for the world's main banking currencies, the dollar and pound largely, causing these two exchange rates to rise higher than they otherwise would have been. This is probably opposite to what at first sight one would expect to occur. Some evidence along these lines also comes from the record balance of payments deficits of these two countries, who have hardly been in surplus since the Banking Crisis stated. Generally when a county's balance of payments deficit becomes significant its exchange rate falls, causing its government to introduce cut-back measures. These exchange rates do not appear to have reacted to record deficits, and little cut back measures have been instituted. The international trading currencies can be expected to have more leeway in this matter than purely national currencies. The international deposit and loan activity may have increased this, and the associated banking crisis increased it further. Thus, the passing of the Banking Crisis should reduce these exchange rates, and also a greater reaction to their deficits. At the time of writing these do not appear to be occurring, and is likely to be a remaining influence of the Banking Crisis.

  3. Property values have shot up from the mid 1990s, and despite warnings from many commentators that this could not continue have in fact continued to do so in the 2000s. This is likely to be the result of the Banking Crisis depressing property prices, so that they rise as the Crisis passes. It will also be a consequence of the near zero interest rates which the end the Crisis seems to have caused. Both these drivers are regarded as short term, and that the serge of price rises will come to an end from these causes in line with commentators predictions.

Other Jolts

As said at the beginning of this Scenario, the Banking system is likely to be inherently unstable in the early Post Industrial period from jolts in the environment in unforeseen ways. The Sectors cited need to be carefully monitored for the sources for the more likely jolts.

A factor which will be important will be if two instabilities occur together. Thus the Banking system is more prone to instability while the Sovereign loan Banking Crisis is occurring. Indeed, the plateau in property values was probably an independent instability, but its impacting with the Banking Crisis made both worse.

Thus a banking collapse in some major region of the world is quite a likely Scenario in the early Post Industrial Period, occurring as on roulette wheel basis (unless one's weak signal monitoring is unusually good). The collapse model indicates that people will be denied access to their funds in these banks for an extended period - putting many of them into insolvency. Governments step in, but they are concerned to save the banks and financial institutions affected - and do little for the quite innocent depositors who may be ruined. (This is generally the opposite to Government action in almost all other problems - where public safety comes first and any businesses at the centre of the problem will suffer and may be left to go bust. The reasons for this extraordinary situation are dealt with in the Government Area, which does not however have general public access.)

It is worth considering contingencies to have basic cash resources outside the banking system. Those who had cash in 1932 banking collapse really cleaned up. They were even allowed to deposit their cash in the banking system, and draw it out - whereas others who had it in the banks from the start of the collapse could not. Diversification of cash holdings may be desirable. Where governments run Savings Banks this is probably the safest of all where people or businesses can have access to such accounts.

Current Crisis - the Credit Crunch

Just as evidence that the 1980s Sovereign Loan Banking Crisis was passing, a new devastating Banking Crisis has quickly spread across the World. Starting in the mid 2000s in US, housing finance houses created a new financial instrument. Having lent money secured on house purchases, they parcelled them up into exotic securities and sold them to investors round the world, on the basis of a new way of dealing with risk - spreading the risk secured on US property. This means they did not have to wait until savers deposited more savings, they got the cash they had lent back quickly, and could lend more for house purchases - bidding up house prices. What was not known generally that this was accompanied by lending to people who had poor credit histories to buy houses (the Sub-Prime loans), and these were included in the exotic securities risk structure.

This Sub Prime problem surfaced in 2007, when borrowers started to default, and it became clear large numbers could not afford to repay. House price rises stopped, and prices fell steeply. Interest payment into the exotic securities fell, and the exotic securities could not pay the interest required. Confidence in the new approach to risk evaporated, and the market in these new exotic securities seized up - as no one knew what they really contained.

It transpired that most banks around the world had stuffed their vaults full of these exotic securities - for the same reason as in the 1980s crisis - lack of real lending opportunities. With their markets seized up, and interest not coming in, they did not have the funds to service their own depositors. Further, as they did not know what other banks held, banks stopped lending to each other.

This crisis also started from the Constant Trend that new financial products are likely to be inherently misconceived. The products have spread all round the world before the crisis surfaced. It has the high chance of causing a world depression. Governments round the world stepped in true to form bailing out the banks, and a forlorn attempt to prevent a recession by huge money printing. We can expect this to cause future inflation. Governments have taken an unusual step of relieving the banks from paying interest to their depositors, through setting government rates a near zero. Banks have followed this for their depositors, while charging high rates to their borrowers. This lack of interest on savings is causing huge problem especially in pension provision. Governments generally cannot control interest rates in this way, and it is a question how long can they continue to do so. The recession which followed was of 1930s proportions - though no one is mentioning the Depression word. The recoveries have been weak, and have hardly yet recovered the recession contractions - parallels what happened in the 1930s Depression.

Ironically only the US where it all started has achieved half decent growth. European countries who tried to stimulate their economies to prevent the Credit Crunch causing a recession mentioned above have plunged them into a further crisis - pushing many towards insolvency. For several decades many Governments have been spending more than they can obtain in taxes leading to Government Fundaing Problems. Several counties had difficulty in servicing their loans, and the future of the new Euro currency being in doubt. Bail outs of one or two small countries occurred - but with fears larger ones could be too big to save. A wave of reducing Government deficits resulted - with protests over the austerity produced. It is doubtful if much real progress has been made in reducing Governments' expenditures.

Large enquiries occurred as to the cause of the Credit Crunch. In the view of the writer these have not got to the heart of the problems, but have focused on Banks having more capital reserves. This is no more than the Romans did - the problem of financial innovations repeatedly being misconceived needs to be tackled - Banking instability problems will continue. Also requiring Banks to have more capital when much of their assets is locked up in un-saleable exotic securities is hindering the Banks' recovery. The Banks have launched scam after scam in attempts to re-build their reserves - which have been spotted by government regulators, who have fined them huge sums, and made them pay compensation. The US legal system has pursued Banks - especially non-US - to achiele huge fines. All of these will be hindering the Banks recovery from the Credit Crunch.

Thus Banking Instability has the prospect of disrupting world economic growth for the foreseeable future, and we can expect another inherently misconceived development to follow - but hopefully not before we have recovered from the Credit Crunch over the next two or more decades. On the plus side, at least these exotic securities are indeed secured on US land and houses. Some loss of interest flows and capital values will occur, but the underlying investments are sound - which was not the case with the 1980s Sovereign Loan crisis.

To return to your Contents page click your URL password (drop down menu below the current URL)