The truth is the last 5 years have been hell on earth for anyone trying to secure business finance on anything like sensible terms. This has been particularly the case for the small- and medium-sized businesses.
After the calamitous failure of Lehman Brothers in 2008, the banks dusted themselves down, reviewed what had happened and the positions they had been allowed to put themselves in by the benign regulatory framework, and then set about restoring their businesses.
Of course what should have happened and, I think it’s fair to say, would happen to any of us if we made reckless business decisions advancing credit to customers whom we already knew had only a slim chance of paying us, is that the businesses should have entered some form of insolvency. Or, in other words, FAILED.
If we cast our minds back to those dark days, there was a good deal of fear around, and if you had any money you didn’t know where to put it. Where would it be safe?
The major international financial nations decided that the best course of action would be to bail out, and therefore finance, these failed institutions to avoid what would have likely have been global Armageddon.
The bottom line is that these businesses failed, and in an effort to retain some form of global financial stability, governments decided to fund them with taxpayers money.
I would argue that the principles of free market economics ended at that time. The moral hazard effect had hit home in a big way.
Moral Hazard – Mervyn King’s approach
The regulators in the UK reacted in a very stern way which, paradoxically, was a criticism of themselves, and their failure to control the staggering rises in credit availability. Banks were made to pay for their exuberance; the former governor of the Bank of England, Mervyn King, was very concerned with the moral hazard effect, and was determined to make the banks toe the line in the new world of ultra-prudent banking. The Americans followed a more liberal line and were not as hard on their banks. It seems that this policy allowed them to return to growth quicker than the UK, but on the other hand they are sitting on one hell of a debt burden, which has in effect been responsible for their government shutting down!
Moral Hazard – Mark Carney’s approach
Mark Carney has come in and sought to relax some of the burdens the banks have had to endure these past five years. His “Forward Guidance” on interest rates – which we discussed a previous post -seems to have helped light the blue touch paper in terms of the availability of property funding. In June the Bank of England relaxed its regulations, releasing some £70bn of liquidity in an effort to increase lending and stimulate growth. Last week, he took a further step and effectively made available cheap funding to banks in times of difficulty secured against lower quality collateral.
This does have the whiff of further moral hazard type problems further down the line. A failing bank, whose normal lines of credit have been cut off, will now be able to go to the Bank of England for funding without having to pay punitive rates of interest.
Possible Solution to this problem?
(Note: I’m not a banker)
Business consultants, and indeed banks, advise their clients to insure against bad debt. Could the banks as an industry not follow their own advice here? Whilst I fully acknowledge they would find it very difficult to obtain this from one of the credit insurers, the whole industry could potentially self-insure. Premiums could be based initially on the size and types of exposure each bank had, and renewals could be based on claims history. First loss could be adjusted accordingly, such that it was high enough to deter claims but low enough that it didn’t bust the bank making the claim.
This would need to be made mandatory to qualify for a banking licence and would go some way to addressing the moral hazard issue.
The main difficulty here, notwithstanding the organisational intracacies, is in terms of international competition. We don’t want to tie one hand behind the back of our banks if those in America, France, Switzerland and Germany are allowed a free rein…
No-one said it was easy.
If you have any comments on this article or would like to discuss any aspect of it please contact me at firstname.lastname@example.org or on 0845 689 8750.
Image by: jonwa60