The non-bank banking crisis, and a solution for the future

Andrew Hunt has pointed out that many UK banks have been behaving as if they were non-banks. This is likely to have been the case in America and elsewhere too.

Hunt points out that:

the problems in the UK banking system have arisen because the banks have, in effect, been behaving as though they were non-banks. Since the end of 2004, the UK commercial banks have expanded their sterling-denominated loan books by some GBP 429 billion. They have also added GBP 53 billion of sterling bonds to their portfolios, giving them a total on balance sheet expansion of circa GBP 480bn to residents since 2004. On top of this, the banks have lent a further GBP 220 billion of sterling to non-residents and although some of these funds may have been used abroad, many may have been used within the UK by companies and individuals acquiring assets in the country. Therefore, the banks have enjoyed total GBP asset growth of circa GBP 700 billion. This expansion of assets has, however, only been matched by a GBP 430 billion increase in resident deposits. The building societies, meanwhile, have increased their assets by around GBP 80 billion but they have apparently only financed half of this growth through traditional deposits. From this, we can gather that the UK banks and building societies have financed between a tenth and a fifth (and at times more) of lending to residents, and perhaps 40% of total GBP credit since 2004 through recourse to the wholesale money markets, thus behaving as though they were non-bank financial institutions.

Thus significant leverage has been hidden in plain sight and the recent trouble with Northern Rock shone a light on the issue.

While there is no easy way out of this one suggestion that bears merit is to consider regulating two tiers of banks.  The banks with a loan to deposit ration of 90% would be able to avail of a guarantee facility, while those with higher leverage would not and customers would clearly be able to see the difference.  This is a simple solution that is transparent and understandable by customers.