There’s no reason the British people’s decision to leave the EU should cause global banking and finance to seize up. Bank of England governor Mark Carney has reinforced to the markets that he has liquidity lines running into the hundreds of billions of pounds to support the system. He’s has taken measures to release capital into the banking system to be lent to businesses and consumers.
He’s pretty much promised more policy easing as well. And the pound has collapsed to its lowest levels in more than 30 years to help cushion the British economy from the expected slowdown in economic activity as a result of uncertainty around when and how Britain will actually leave the EU.
All of that is in central bankers’ home turf which, as Goldman Sachs said in the wake of the Brexit vote, means Mark Carney and his colleagues at the ECB, the Fed, the BoJ, and elsewhere should have this covered.
But like chaos theory’s butterfly in the Bahamas, the natural desire of investors in a number of UK property funds to protect their capital from a potential downturn by withdrawing it from these funds has an eerily similar feeling to events that led to the collapse of Bear Stearns and Lehman Brothers, which triggered the GFC.
That’s because the enlightened self interest of individual investors wishing to protect their capital by withdrawing funds has coalesced into a volume of withdrawals too large for what are illiquid funds – given they invest in property – to cope with.
So individuals acting rationally create a tragedy of the commons; they have caused three prominent funds to suspend withdrawals.
Calling back money
That’s the type of action which haunts central bankers, money managers, and traders attuned to averting a rerun of the deterioration of trust within the financial system that such redemption halts create.
Think about it. Those investors locked into the funds by the redemption halts then seek their cash from other investments and other markets. That creates liquidity pressure elsewhere, and can drive prices lower. This is exactly what Mark Carney and his global central banking cousins are trying to avoid.
Everyone recalls the closure of special investment vehicles (SIV’s) by Soc Gen in the middle of 2007 which hinted that something was amiss in global finance. These closures were followed by other high-profile casualties as the liquidity pressure spread and money was called back from counter parties.
Bear Stearns eventually collapsed in March 2008 to be followed by a string of problems and tightness in global liquidity which ultimately included Northern Rock in the UK, Icelandic banks, AIG, and of course Lehman Brothers.
Don’t get me wrong. It is still a long hop from the suspension of redemptions at Aviva, Standard Life and The Pru to a full blown financial crisis. Britain is just not that big an economy on the world scale these days.
But trust and confidence is the bedrock of financial markets. So the price action in the British pound, gold, stocks, and commodities in Asia today shows investors have moved from alert to alarmed.
The pound may be back at $1.2930 now but just a few hours ago it was reading below $1.28, levels not seen for many decades.
One of the primary reasons for this is that as a nation with a 7% current account deficit Britain needs the confidence of global investors to lend it the cash to fund that debt. British Banks intermediate that debt.
So a buyers’ strike, let alone outright selling of UK assets, threatens the economy and crucially the British banking system.
That’s important because three of the 30 banks listed by regulators as systemically important on a global basis, HSBC, Barclays, and the Royal Bank of Scotland call the UK home, while another – Santander – has significant operations in the UK.
That means troubles in British banking can spread quickly if investors lose confidence in the system. And that is the transmission mechanism which causes a nightmare scenario loss of confidence.
Then there’s Italy
Mark Carney is doing his best. But the political vacuum at the top of UK politics is unlikely to be filled unless the Conservative party takes the bit between its teeth and pulls forward the leader vote again. September is too far away in the current circumstance of irreducible uncertainty.
But it gets worse.
Italian banking is on the brink. Monte Paschi de Siena is both the world’s oldest bank and the most high profile institution in danger of collapse. Its share price has crashed under the weight of non-performing loans and the ECB, unhelpfully, in the past week has added to its woes by saying it has to cut a large chunk of those loans.
But in the post Brexit world, with democracies fracturing and with an eye to the upcoming referendum Italian prime minister Matteo Renzi can’t stand by and let the bank fail.
So he’s in a face off with Brussels and Bundesbank president Jens Weidmann who wants more centralised control and rules around government debt and deficits. Rules which would effectively lock Renzi out of a taxpayer-funded rescue.
The largest bank in Italy, UniCredit, is at risk of being drawn into any conflagration involving the nation’s sector.
And yes, UniCredit is also in that list of systemically important banks globally.
Perhaps Renzi can act while Weidmann is otherwise occupied.
Last week the IMF called Germany’s Deutsche bank the most systemically dangerous bank in the world.
Deutsche also conditionally failed the recent Fed stress tests again.
Trust and confidence is a fragile thing in finance. 2016 has shaken market confidence. Brexit is now at risk of turning a politico-economic issue into one of trust in the UK banking system.
From there it’s only a short hop to a broader banking crisis as risk managers all over the world call cash back in order to reduce their risk.
Individually that makes sense. But as we saw in 2008 done at a system wide level a crisis is the result.
No wonder bankers are getting worried again.
Greg McKenna is contributing editor at Business Insider Australia. He is a former chief currency strategist at Westpac and NAB.
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