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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
“It is taking too long for the increases in interest rates to be passed on to savers.” So said UK chancellor Jeremy Hunt this month, responding to the fact that, following the Bank of England base rate hikes of recent months, banks have not increased the interest on savings accounts as fast as they have hiked mortgage rates.
His rhetoric — amplified by a veiled threat that this is “an issue that needs solving” — is understandable, laudable even, given the stress on consumers at a time of high inflation. As with the supermarkets over petrol prices, and energy companies amid the Ukraine war, it is undoubtedly good politics for the chancellor to attack banks for seeking to profiteer. But is it economically smart?
Short-term, it might be. In addition to benefiting consumers, higher savings rates would logically help achieve one of the key aims of the BoE’s rate hikes — namely to curb consumption and hence inflation.
But there is a longer-term contradiction. In his Mansion House speech a week ago, Hunt bemoaned the “declinist narrative” that is setting in when describing the UK’s economic prospects. “A strong City needs a successful economy, and a strong economy needs a successful City,” he explained. Undermining banks’ margins arguably erodes their financial strength, weakens the City and thus the industry’s ability to fuel the economy.
In recent days the banks have nudged up their savings rates, either because of duress from politicians and regulators or for other reasons. (Banks offer higher rates when they want to generate funding but it may sometimes be cheaper to opt for alternatives, such as covered bond issuance.) Any policy regime that forces a bank to offer higher interest rates than it needs for commercial purposes will distort its balance sheet.
But the underlying accusation — that banks have been profiteering — is worth examining. If they have, then we have a bullying, rapacious City, rather than a strong, supportive one.
The evidence, though, does not support that view. The so-called net interest margin of banks — the difference between what they offer depositors and what they charge for loans — is running at roughly the long-term average. Yes, it has risen over the past year or two, but that was from historically thin levels, caused by an exceptional period of ultra-low interest rates.
All else being equal, thin net interest margins are a key driver of lower profits, which in turn make banks less attractive to investors. And so it has turned out. Just compare UK banks with peers in the US, where interest rates and margin levels have been higher, and where the economic outlook is brighter. UK lenders command sharply lower valuations. Shares in Lloyds, Britain’s biggest high street bank, are trading at 63 per cent of the value of its net assets. The equivalent price-to-book ratio for JPMorgan Chase, the US number one, is 156 per cent. This doesn’t just matter in the abstract. It matters for reasons of financial stability.
By chance, the Bank of England last week revealed the results of its annual stress test of the big UK banks. It gave them a clean bill of health, reflecting the broader picture that regulators have sought to emphasise in recent months — namely that despite the troubles of a few US regional banks and the collapse of Credit Suisse, the banking system as a whole is solid, with robust capital to support it.
The stress test scenarios, established early last year, sounded dramatic. But some are far from that: within a matter of months the base rate has already spiked to 5 per cent, for example, just shy of the 6 per cent stress test number, and may well have to go higher to bring down stubbornly high inflation. In other words, real-life stress could well prove more challenging than the test.
Banks might need to raise fresh equity in that case. But at valuations below 100 per cent of book value, that becomes challenging, both for the bank in terms of cost, and for prospective investors in terms of appeal.
When BoE governor Andrew Bailey chimed in last week to urge banks to pass on interest rate rises to savers, saying “it’s important rates get passed through”, he was running a risk. He might argue his language was careful and justified in part by the anti-inflation logic outlined above. But he must be careful: as a prudential regulator, the governor’s job is not to be a popular champion of consumer interests, but a guardian of solidity. In times of real crisis, a minimally profitable banking system, with a stubbornly low stock market valuation, is unlikely to prove convincingly robust, whatever the stress tests might say.
