Ten years ago, queues quietly began forming outside branches of Northern Rock. Unsettled by press reports that the bank was asking for help from the Bank of England, anxious customers wanted out. The first run on a UK bank for over a century was underway, and Northern Rock would be nationalised within a year.
In the past decade, banks have changed enormously. The Northern Rock business model of relying on wholesale markets for short-term funding has been eliminated. Banks have been forced to hold more and better-quality capital. On the whole, lending standards have improved.
Oversight of banks is much improved too. A regulatory audit discovered that bank supervisors had met Northern Rock staff only seven times in the 18 months leading up to the run. This was not unusual. Nearly every area of global regulation was found wanting during the crisis. Today, the levels of scrutiny are stronger.
But none of this means that a bank run won’t happen again. All bank runs boil down to a loss of confidence – something that is impossible to really eliminate. What changes is the cause. So what could prompt a bank run in the years ahead?
One trigger could come from high levels of consumer debt. The New York Federal Reserve announced earlier this year that household debt had surpassed 2008 peaks to reach $12.73 trillion. The New York Fed wasn’t directly concerned by this, but highlighted the fact that auto-loan and credit-card delinquency rates are going up and those from student loans are “stubbornly high”. The Bank of England has also expressed concerns about mounting levels of consumer debt. The worry is whether this run-up in debt is sustainable for the banks doing the lending.
Problems with a bank’s capital could be another trigger. Earlier this year, these led to Banco Popular Español suffering an ‘invisible’ bank run. No queues of anxious customers formed, but deposits evaporated, and the bank’s liquidity went with it, after concerns about the bank’s non-performing loans (NPLs) reached a tipping point. Investors had become increasingly sceptical that the bank had adequately provisioned for its stock of NPLs. The chorus of dissent about the bank’s capital eventually caused depositors to flee, taking the bank’s liquidity with it.
Although it was eventually bought by Santander, some questions about Banco Popular remain unanswered. The European Central Bank (ECB) claimed that Banco Popular’s downfall was due to a liquidity problem. But liquidity only disappeared because of problems with the bank’s capital. It’s unsurprising that the ECB pins the blame on liquidity since Banco Popular passed its own stress tests, which were intended to assess a bank’s ability to withstand conditions like a bank run. The ECB had signed off on Popular’s capital position, so to admit there was a problem with it would mean a loss of credibility. Either way, investors are a good deal more cynical about the usefulness of the central bank’s stress tests now.
Banco Popular’s rescue has shown that the regime set up to resolve failing banks does work on some level. But it was faltering, and that’s damaged the perception of how it might work in the future.
The tests for the resolution regime could come from a number of European countries. The number of NPLs in Europe is coming down, but it’s still much too high – higher than in the US and UK. In Cyprus and Greece, about half of total loans are non-performing. They’re placing real strain on bank profitability and make the institutions less capable of withstanding unforeseen shocks. The Greek and Italian banking sectors need widespread reform and pose a risk to the wider economy. The problem that caused the sovereign crisis of five years ago – the link between the solvency of a country and its banks – has never been dealt with fully. Populism has not gone away in Europe, and the antipathy of parties like Italy’s Five Star Movement to the euro and banks is a real threat. If another sovereign crisis returns, the link between the solvency of a state and its banks will once again be strained.
All of the changes that have happened in the banking industry over the last decade have done so against a backdrop of almost limitless liquidity.
Under the cloak
But perhaps the biggest threat of future bank runs comes from central banks. All of the changes that have happened in the banking industry over the last decade have occurred against a backdrop of almost limitless liquidity. The changes to some banks have been so significant that they are, to some extent, a product of that liquidity. This has had many effects on the sector, including what amounts to the cloaking of risk.
The problem will come as central banks gradually remove that cloak of liquidity. When that happens, it’s reasonable to expect we’ll see something we don’t like. We have suspicions of where such problems might lie – in consumer debt, for example. But we won’t know for sure until central banks step back. History might not repeat itself in the banking sector, but we could yet hear echoes of the past.
The article above was previously published on Aberdeen Asset Management’s ‘Thinking Aloud’ blog on 14th September 2017