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BLOG: Just how ‘resilient’ is the UK financial system?

Kit Klarenberg
Written By:
Kit Klarenberg

The UK’s ability to absorb another major financial crash was much discussed in the years immediately following the crisis of 2008/9. Now, however, there is seemingly mainstream agreement that the UK is not only recovering, but has learned from the mistakes of the past, and is resistant to further shocks.

For instance, the Bank of England’s June 2014 Stability Report deemed the UK to be financially resilient, and equates resilience with capital ratios. The BoE’s argument runs that a close relation between assets and capital held by banks results in more resilient banks, and thus a more resilient system overall.

  • Definitions

The New Economics Foundation, however, believes such reasoning erroneous – and, potentially hazardous. The think tank proposes a new definition of the term;

“The capacity of the financial system to adapt in response to both short-term shocks and long-term changes in economic, social and ecological conditions, while continuing to fulfil its functions in serving the real economy.”

It also details a new method of measuring financial, based on academic studies and policy literature, identifying a septet of attributes that signify and influence resilience;

  1. Diversity

The most resilient systems have a varied array of independent financial institutions that serve separate functions, occupy different spaces, and provide different products and services.

  1. Interconnection

The extent to which financial institutions are intertwined is correlated to their vulnerability, and how far – and how fast – financial problems proliferate. The greater the interconnection, the higher the risk of contagion. This notion is supported by Andy Haldane, BoE chief economist.

  1. Size

The larger a financial system is relative to the national economy in which they operate, the less stable and resilient that financial system – and economy – is.

  1. Assets

What institutions invest in, and where,  plays a role in overall sector resilience, as assets have different degrees of susceptibility to financial booms and busts.

  1. Liabilities

Institutions in the most resilient financial systems rely more on customer deposits than lending to and borrowing from other banks.

  1. Complexity

The more complex a financial system and the products within it are, the more risks are spread throughout it.

  1. Leverage

The lower the ratio between banks’ assets and capital, the more robust a bank is. In the years following the financial crisis, the governments of major developed economies have all focused on this issue, to varying degrees.

  • Findings

The NEF Financial Resilience Index ranks the UK very bottom in the G7, with a rating of 27 out of 100. Every other G7 country scores far higher; the US 56, Canada 62, Italy 63, France 66, Japan 71 and Germany 73.

This is perhaps unsurprising.

The UK banking system is the largest among the G7, in terms of bank assets as a percentage of GDP. It has consistently grown in size since the year 2000, at a far faster rate than any other advanced economy.

The UK banking system is also the most interconnected in the G7, with financial institutions lending to each other at far higher rates than any other advanced economy – and UK banks hold the most foreign assets. The UK has the highest levels of private household debt among the G7, meaning interest rate rises have a disproportionately damaging impact on borrowers.

  • Reform

Evidently, if we are to insulate ourselves against another financial crisis, reform is vital.

The UK could immediately benefit from the growth of alternative financial institutions and sectors, which challenge the entrenched financial establishment. At present, the UK has the most concentrated financial system in the G7; cooperative, mutual and public savings banks accounting for just 18 per cent of the market, with the rest being publicly traded entities, owned by shareholders.

The rise of P2P lending in recent years is certainly cause for cautious optimism in this regard; although it needs to grow further, there is much to suggest this trajectory will materialise in due course. For one, investors are still forced to choose between negligible returns from safe products, and higher rates from volatile products. For two, P2P borrowing is no longer the preserve of individual consumers who cannot access loans via traditional sources – recent figures indicate that the growth of peer to peer lending for businesses has surpassed personal lending. For three, P2P is now being supported by other areas of the market. Recently, challenger upstart Metro Bank partnered with P2P provider Zopa; Paul Riseborough, managing director of customer propositions at Metro Bank, says the bank is “committed to supporting the growth of alternative providers in order to bring real choice to consumers.”

“We believe that true competition in the market will come from differentiated models, creating choices for consumers and businesses.”

Irrespective of the geography of the next economic downturn – whether global or national – and regardless of its timing – whether five or 10 years down the line – something’s gotta give. It’s economically and morally necessary.