Brexit Pain Begins for Banks
Posted by hkarner - 22. Oktober 2016
Source: The Wall Street Journal
Lending problems start to show as central bank faces currency and inflation pressure
The British pound is down and inflation is up: this signals danger ahead for the Bank of England and U.K. banks.
More than three months on from the Brexit vote, the first hard data showing a slowdown in lending is emerging. Banks will give more details with third-quarter numbers from next week. So far, the U.K.’s decision to leave the European Union has pushed up some defaults and added pressure on profits, but the bigger risks of rising credit problems still hang over the sector.
In the past three months, defaults on unsecured consumer loans have suffered the sharpest jump since the second quarter of 2009, according to the Bank of England, but this hasn’t spread to other types of lending. However, more problems are likely over next year and beyond due either to rate rises or higher living costs and a slowing economy.
The U.K.’s major vulnerability post-Brexit is its reliance on foreign investors to fund its yawning current-account deficit. If foreign investors flee, the pound will fall further and yields on U.K. government debt rise, while sky-high property prices would take a hit.
Analysts believe an interest-rate increase to attract investors and defend the pound would be the last resort for the Bank of England. Such a move could cause an increase in defaults among highly indebted U.K. consumers, especially recent home buyers in London and the southeast.
There are hopes this won’t happen because the falling pound will shrink the U.K.’s current-account deficit, which stands at 6% of GDP. But this won’t be achieved by normal avenues of higher exports or because the country attracts safe-haven flows. U.K. exports compete on quality not price and the pound hasn’t historically behaved like a haven currency.
What should help in the near term is the international investment position, where the fall in the pound will lift the value of overseas assets and income. A 20% decline in sterling could cut 2 percentage points from the deficit, according to Morgan Stanley, though that is predicated on a eurozone economic recovery.
The rest of the economy already has higher input prices for manufacturers and higher food and energy prices for everyone, which hurt.
The other short-term impact of Brexit is lower demand for credit across the board, according to the Bank of England. Some banks have seen commercial loan demand recover during September, but don’t know how sustainable that will be. The summer interest-rate cut has helped the economy but at the cost of bank profits.
For banks, the really damaging risk of foreign capital flight and a current account crisis probably remains an extreme one. But the broader slowdown and pressures on consumer income that will make life harder for borrowers is under way. Even in this relatively positive scenario, banks come out losers.