Good banks leave their weak rivals behind

Allister Heath
THERE are three main messages from Barclays’ and HSBC’s results yesterday. British banks are divided into two groups: strong, private firms that have continued to generate profits during the crisis; and weak players that had to be bailed out. It is simply wrong to claim that all banks are the same. It is also clear that universal banking has increased rather than reduced stability: Barclays’ high street banking operations have suffered as a result of consumer defaults, while its investment bank has powered ahead. Being large, diversified and global has helped Barclays and HSBC; breaking them up or forcing them to sell off their investment banks would weaken, not strengthen, the UK’s financial stability.

Last but not least, unless we see a double-dip recession next year, the financial system is passed the worst, with delinquencies and defaults likely to start to get better in 2010.

But while Barclays and HSBC are doing well, many problems remain for weaker banks. These are mainly due to the fact that high street and commercial banking is inherently risky.The problems have nothing to do with investment banking, which by comparison is reasonably safe. Traditional banks borrow short – from consumers in the form of deposits that can be withdrawn quickly – and lend long, for up to 25 years in the case of mortgages, loans that cannot simply be called back whenever the bank needs the money. Economists call this mismatch between the timing of assets and liabilities “maturity transformation”; an observer from Mars might call it a catastrophe waiting to happen.

Fortunately, banks are usually able to rely on their customers’ belief that they will be able to get hold of their deposits whenever they need them, which is why – until Northern Rock – Britain went over 100 years without suffering a run on a bank (there may well have been one in the late 1970s but it was hushed up). Two developments exacerbated this mismatch this time around; one has yet to be tackled.

The first was the use of money markets to supplement deposits and to generate more funds to lend out. It turned out that these are much more prone to panicking and seizing up than ordinary consumers. The second was that the maturities of banks’ publicly traded debt (wholesale debt) have shortened in recent years, according to Moody's. In other words, banks are selling IOUs that need to be repaid more and more quickly. This problem has not been resolved over the past 18 months; if anything, it has got worse.

Globally, average wholesale debt maturities issued by banks fell from 7.2 years to 4.7 years, the shortest maturity for new debt in 30 years. Moody’s estimates that banks will face maturing debt of about $10 trillion between now and the end of 2015, 70 per cent of which will come due by the end of 2012. In the US, the maturity of bank debt has fallen from 7.8 to 3.2 years over the last five years. In the UK, it has gone from 8.2 to 4.3 years. As a result, banks in these two countries will face over $2 trillion of maturing debt between now and the end of 2012.

While these are crazy figures, the industry will probably find the funds. But the magnitude of the task will mean higher financing costs, which will be passed on to borrowers; it will put pressure on banks to shrink their balance sheets, limiting the growth of credit. It also means that the gap between strong banks and weak banks will grow even wider. Investors have been warned.