A Sign of Recovery: Back to the Old Normal?
An interesting chart on page 72 of this week's Economist shows European bank funding costs falling below that of investment-grade corporates for the first time since 2009. This may not have the headline-grabbing weight of an improvement in the inflation or unemployment statistics, but it is just as significant.
This development might just be the first definitive sign that we are over the worst (euro zone implosion excepted, of course), because it takes us back into "normal" territory. The standard business model for banking assumes that a bank funds lower than the corporate customer it lends to – if it did not, not only would it cease generating new loans at the market rate (because they would be loss making), but in addition the corporate would have no need to raise funds from its banker, as it could obtain funds cheaper from the wholesale market direct.
This is a gross simplification of course; many corporates (particularly in the SME sector) cannot access the capital markets, and in any case banks may view their customer relationships beyond solely the lending decision. For corporates who fund from the banking sector, it has meant that the higher cost of bank funding has hit them harder at a time when economic conditions are at their most uncertain.
Why the turnaround? Has the international investor community decided European banks are healthy again? Only up to a point. It is really central bank monetary policy action that has generated this new development. The multi-trillion injection of liquidity on both sides of the Atlantic has resulted in banks having access to all the funding they need, such that they are issuing less debt themselves. This has depressed bank debt yields. This is, to an extent, an artificially-induced situation which may just be storing up problems for the future: after all, what will happen when central banks start to unwind their quantitative easing, or start raising the bar with respect to the quality of collateral they will accept?
The hope is that economic recovery will be sufficiently grounded by then such that bank funding rates don't suffer when QE (quantitative easing) is reduced, and the interbank market and debt capital markets are thriving again.
But it's a start. Bank borrowing rates lying below that of their corporate clients is a welcome return to the "old normal" and one that reaffirms the viability of the traditional business model, at least for now. Amongst all the economic news releases we have to absorb every day, this one is a genuine positive development.
Professor Moorad Choudhry is Treasurer, Corporate Banking Division, Royal Bank of Scotland.
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