Recent economic data have painted a more positive picture of business activity for most developed economies. For example, service sector PMI data for April point towards expansion at the fastest rate in a year raising hopes that a more protracted economic slowdown can be avoided. Odds of a recession or even a single quarter of contraction have shortened substantially since last winter.
However, complacency would be premature. The recent failure of First Republic bank has shown that the ripples of the banking crisis continue to move through the financial sector and – at the time of writing – California-based PacWest looks like it could be the next victim.[1]
Banks in the UK and Europe so far seem to be less affected – with the high-profile exception of Credit Suisse though the reasons for the Swiss bank’s downfall precede the current market turmoil. However, beneath the surface there are signs that banks on both sides of the Atlantic are reacting to the new economic environment by becoming more cautious and dialling back new lending – to the detriment of the real economy.
In the Eurozone, the latest European Central Bank (ECB) bank lending survey shows that in Q1 of this year banks reported the highest pace of net tightening in credit standards since the sovereign debt crisis in 2011.[2] Similarly, in the US credit conditions have become exceptionally tight. According to the Credit Conditions Index by the American Bankers Association, expectations for credit market conditions are at their lowest since the start of the pandemic, suggesting US firms will find it tougher to borrow from banks in the coming months.[3]
In the UK, the Bank of England’s (BoE) Credit Condition Survey so far does not show a significant deterioration in credit availability to the corporate sector, though answers to the latest survey were collected before the collapse of Silicon Valley Bank (SVB) and we might well see a more negative picture in the next survey wave. Other measures, such as the Voice of Small Business Index, which Cebr produces for the Federation of Small Businesses, shows that over half of small businesses in the UK rate credit availability as poor, the worst reading on this measure since Q4 2014.[4]
What is causing this synchronized credit crunch and what will the consequences of this be for growth?
Interest rate hikes since the end of 2021 are the main driver for banks’ current predicament. While the risk management of SVB seems to have been exceptionally bad, it is quite likely that other banks too hold some longer-date government bonds that have lost value since central banks around the world decided to jack up rates. These securities are counted as assets on banks’ balance sheet so that if their value falls, liabilities (i.e. deposits) eventually need to be reduced too. Moreover, reluctance especially by US banks to pass on higher interest rates to their savings accounts means that deposits have left the banking system at an astonishing rate. Estimates put the drawdown at JPMorgan, Wells Fargo and Bank of America over the past year at over half a trillion dollars.[5] Meanwhile, Brits pulled a record £4.8bn from UK banks in March alone, as bank failures in the US caused concern about financial stability. A loss in deposits will also affect how much a bank can loan out without risking falling foul of specific loan-to-deposit ratios stipulated by regulators.
In summary the data suggest that companies (and to a lesser extent potential homebuyers) will find it increasingly difficult to obtain a loan in the coming months. This will have a dampening effect on investment and economic growth, and is one of the main reasons for our more pessimistic outlook for the global economy. Our latest forecasts put GDP growth for 2023 at 0.8% in the US, 0.7% in the Eurozone and 0.2% in the UK. The negative impact on growth will only become stronger the longer interest rates stay at their current high levels. Central banks will find themselves in a difficult spot as we expect core inflation to also stay higher for longer than currently predicted, making it more difficult to cut interest rates in a bid to stimulate the credit market. The current rate hike cycle might have come to an end in May, but the job of the Federal Reserve, ECB and BoE is unlikely to get any easier in the coming months.
[3] American Bankers Association
Net percentage of lenders reporting tighter lending standards
Source: ECB Bank Lending Survey
For more information contact:
Kay Daniel Neufeld, Director and Head of Forecasting and Thought Leadership – Email: kneufeld@cebr.com – Phone: 020 7324 2841
Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.