The UK has recently undergone a banking crisis, the reasons for which have been much analysed, but basically boil down to a mixture of liquidity problems (banks unwilling to lend to each other) and solvency problems (assets being valued lower than expected and off-balance-sheet liabilities materialising on the balance sheet).
I think it is uncontroversial to say that the activities that gave rise to the solvency problems are not the mainstream business of the UK banking sector, which focuses on lending to domestic customers – both personal and corporate. I would like to briefly look at the prospects for these two sectors, which represent the main assets of the high street banks.
Personal loans can be split into secured and unsecured loans. The former are mainly secured against the value of a property. Such properties, which are declining in value at an alarming rate, are often mortgaged by up to 125% of their value. Though interest rates are low, unemployment is rapidly rising, meaning we are likely to see a large number of defaults.
Unsecured loans are predominantly made up of credit card debt against households which are breaking all records for indebtedness. These are households facing wage freezes and rapidly increasing levels of unemployment.
Then there is the corporate sector. We are currently witnessing a series of bankruptcies of high street shops. This will inevitably work its way up the supply chain to wholesalers and manufacturers, resulting in more bankruptcies and more unemployment and creating a positive feedback loop of less spending in shops, lower property values etc.
Vacant properties spell trouble for the already distressed commercial property sector. You only have to look at the London skyline to see the huge number of soon-to-be-completed empty buildings – many of which represent bank collateral. And then there is the recent fashion of leveraged buy-outs and high gearing so that companies maximise their leverage potential in profitable times
All of this means banks are facing wave upon wave of bad debt, at a time when they are already distressed and have just been bailed out. The government will probably chose again to rescue the banks, but the three main high street banks’ liabilities are each greater than the UK’s GDP.
The British government’s debt is already growing and its credit default swap rates are rapidly rising. It also faces collapsing tax revenues and increased expenditure. Iceland has shown us what could happen next – a further collapse in the currency and an IMF bailout.
So what should the UK government be doing now? Before a storm you batten down the hatches. The big risk is sovereign default. It is probably too late but the government should be reducing debt and building up reserves – in fact the exact opposite of current policy.