The size of the UK’s banking system does not – and did not – make the UK vulnerable to large losses in growth in the event of a financial crisis, research released today by the Bank of England shows.
Instead, other factors are key to determining the economic impact of banking crises.
“The empirical analysis in this article does not find a strong link between banking system size and the probability or output cost of a crisis, at least once the resilience of the system is taken into account,” the research said.
A simple analysis appears to show countries with smaller banking systems were protected from the crisis, but this relationship could be misleading if there are determinants of banking crises which are correlated with banking system size.
“Once credit booms and capital resilience are taken into account, banking system size would not have helped to predict which countries suffered a crisis,” the report said.
The research looks at whether countries with large banking systems suffered weaker growth after the crisis. The economists were unable to find any significant relationship.
“This calls into question the importance of banking system size in explaining countries’ post-crisis output performance,” the research said.
Looking at smaller nations with large banking systems, the researchers found their case supported. Ireland, Hong Kong and Singapore had similarly large banking systems relative to their economies, measuring around 600 per cent of GDP.
Hong Kong and Singapore emerged from the crisis relatively unscathed while Ireland suffered a major banking crisis.
The authors note that Ireland’s banking sector roughly doubled in size between 2000 and 2005 whereas the Hong Kong and Singapore were broadly unchanged.
The Hong Kong and Singapore banking systems were also had more capital relative to their assets.