Trickle of Banking Failures

Banking is unstable, so says a recent Economist. The Business Trends Library finds that the World Economy is likely to be plagued with Banking Crisis - one starting before the previous one has receded.

With Banking being unstable, a jolt in the Business Environment may be enough - or a re-occurring problem occurs - new financial developments tend to be misconceived.

Thus in the 1980s Banks did not have sufficient sound lending opportunities to deploy their deposits, so started large scale lending to Nation State Governments. The record of History clearly shows it is unwise to lend to Sovereigns - as they cannot be forced to repay. But the view was taken that Sovereign Governments cannot go bust - yet so much was lent to them that they were unable to repay. We had the Sovereign Banking Crisis. It is worth looking at a model of a Banking Crisis so see how it spreads among Banks and Countries. 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 Banks due to a Customs Union - 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

• upon large withdrawals or defaulting loans a bank has to rebuild its reserves, which it can do by
  1. calling in its loans
  2. selling assets
  3. increasing interest rates to existing borrowers (but only if general banking interest rates are rising as other banks have the same problems)

• thus in the early stages 1 or 2 is applied which results in
  1. calling in loans can only generally be done by bankrupting borrowers, which results in loans to other banks defaulting directly with associated creditors - thus problems tends to spread to other banks anyway

  2. selling assets - but as crisis spreads to other banks asset values plunge - losses occur on such sales, resulting in the banks needing to build up further assets resulting from these losses

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

• . raising interest rates increases default among existing customers. Raising interest rates considerably will exceed borrowers ability to repay - so default spreads from the marginal to the otherwise viable enterprise or person

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, 1980s, 2010).

There will be a trickle of banking failures - which is occurring now - 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, Sovereign Loans 1980s, Credit Crunch 2010- ).

The existence of an organisation into which people's savings are put seems to reduce the need to inspect what goes on within it. Value is apportioned to the document representing the savings rather than the use of the money. Hence the emergence of the single intermediary South Sea Bubble entities in the former USSR.

House purchases institutions used to be typically short chains, perhaps only 2 remove from the saver. If they borrow from banks they become 3 remove, and if from the money markets 4 or more remove. In the Credit Crunch, where the complex securities seem to have been traded round the world, it is indeterminable how removed the ultimate savers are from the use of their money.

Such big enquiries follow - but these seem to repeat the Roman reaction of requiring the Banks to have more liquid reserves. The causes such as lending to Governments beyond their ability to repay, or US Sub-Prime issues of packaging mortgages into exotic securities is not tackled.

What is the cause of this crisis? It is somewhat simpler than the previous, but was not spotted. Governments kept interest rates very low after the Credit Crunch, so Banks had a high turn from what they paid their depositors (almost nil) and what they charged borrowers. Governments ran large deficits, partly on the excuse that interest rates were low, but in the longer term can be expected to cause inflation. Then we get the Ukraine War causing shortages, and inflation takes off - Governments then raise interest rate in a attempt to counter inflation. Meanwhile the Banks, again looking for sound lending opportunities have bought stocks in Stock Markets - that is to say Stock representing loans that firms have raised in Stock Markets. The problem is that the traded value of such Stocks goes down if interest rates rise - even below the value that the firm will repay at the end of the loan period. It might be thought that investing in such Stocks is near liquid resources - since sale is easy - but in the situation that has arisen such sale involves a loss with rising interest rates. This is the problem occurring for the Banks when one needs such sale to meet depositor withdrawals. Needing to make such sales at a loss is part of the model discussed above.

Governments have started to announce that their Banks are sound. But there have been a trickle of Banking failures in US and Europe - each of which has inflicted considerable damage. Bank share prices have fallen World wide. We will be lucky if Governments are right. Banking Stability, Scenarios from the Business Trends Library', www.BusinessTrendsLibrary.co.uk, Email: Email

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