Hamish McRae: Libor fiasco will make borrowing harder

Economic View

The move towards a world where people have to use their own money to buy anything rather than borrow other people's has taken another lurch forward – a world where banks have to say "no" rather than like to say "yes". The reason: the Libor debacle. It is hard at the early stage to put any numbers on the costs to the banks that will result from fines and legal actions but it is clear that it will hasten a change in the culture of the industry and also the speed at which it will shrink.

Click here to view the graphic

In the coming weeks we will have a string of stories about fines being levied on the big banks. Presumably these will be larger than that imposed on Barclays, which hoped that by doing a deal swiftly it would gain more lenient treatment. So we are talking fines running in the billions. In relation to the size of the industry this will be bearable – tiny compared with losses from dodgy property lending.

There are however two other elements. One will be private legal actions against the banks; the other possible criminal charges. There is not much point in speculating about the latter, except to observe that the risk/reward ratio for anyone in a senior job in banking has shifted dramatically. But were the legal course to follow that of the class action against BP over the spill in the Gulf of Mexico the numbers become very big indeed.

The Libor cloud will hang over the banks for five years or more and will have a number of effects.

For a start, the entire syndicated loan market is undermined. It is hard for us to remember a world before the money markets – before Libor was coined to describe the rates at which they lent to each other on them. For Libor dates back to the 1960s, to the early days of the Eurocurrency markets, when London-based banks hit on the idea that they might trade deposits with each other over the phone, instead of relying on their own deposit base to fund their loans. (It is the London Interbank Offered Rate.) Syndicated lending, splitting loans between a group of banks took off on an international scale when banks were confident they could go into the market and buy the deposits they needed to fund their bit of the loan.

So without the London-based deposit markets, the great expansion of the world economy would have had to be financed by securities markets instruments. Undermine confidence in the pricing of those deposit markets and the entire banking system of the past 50 years is undermined. If you don't trust Libor, you have to peg loans to something else.

You can do that. Before the present system all rates were tied to one set by the central bank, in the case of the UK it was Bank rate. Many mortgages are still tied to Bank rate's successor, base rate. That is causing losses for many banks because base rate is so low that they are losing deposits, but at a retail level there is enough stickiness to enable the system to work.

At a commercial level, money is less sticky. Large depositors shift cash around for the best rate – or rather the best rate from a panel of banks they deem safe. If big depositors take their money away from banks, putting it perhaps in government bonds, those banks cannot fund their loan book. The result is they make fewer and/or smaller loans.

The next effect of a loss of trust in Libor is a loss of trust in banking as an industry. Banks are being urged to raise more capital to protect themselves and their depositors. But they have over the past four years been a terrible investment. The left-hand graph shows how, that Japan apart, banks are worth less than half the level they were at in 2003, relative to the market as a whole. This is not a pretty prospect for investors, made worse if the bank may be sued. If banks cannot raise more capital they have to shrink their balance sheet. In other words, they have to make fewer and smaller loans.

Put this together and there are at least four ways the Libor disaster will undermine banking globally.

First, bankers will be more cautious. They will be custodians of other people's money rather than go-getters taking risks, as they will punished if the risks go wrong and not rewarded if they go right.

Second, the cost of fines and other legal actions will reduce their profits, which are needed to help build up their capital base. If banks cut dividends, or delay their return to paying them, that reduces their hope of raising new capital.

Third, their core commercial business of making loans tied to Libor has been undermined and will shrink.

And finally, aside from the direct impact on their capital-raising ability, there is an indirect impact on this from reputational damage.

So: banking becomes smaller relative to the size of the economy. We will borrow less and pay back faster. And we will do so when we are already under pressure to service our existing debts. A final twist to the story is that debt service ratios in the UK particularly have until recently still been rising, as the right hand graph shows. This is the sum of interest payments and debt repayments. We still have a long trudge ahead.

It's no game when Nestle's a sweeter bet than the whole of France

Two euro-related stories caught my eye at the weekend. One was a little news item noting that Nestlé, the world's largest food company, can borrow more cheaply than France.

According to Bloomberg the maker of KitKats and instant Nescafe coffee sold €500m of bonds due in 2019 at a yield of 1.56 per cent.

France's debt for the same duration was trading at 1.58 per cent. Moral: investors think a large corporation is more likely to repay debt on time than the second largest country in the Eurozone.

The other one was a rather naughty bit of research by Bank of America, which applied game theory to the plight of the euro and concluded that Italy would be able to leave relatively easily and, if managed properly, would gain from leaving – actually gain more than Spain or Greece.

Ireland would also gain from leaving, but not as much as Italy, according to the BoA's analysts. Germany, of course, would find it easiest to leave but would gain least from doing so.

Indeed it would suffer from Italy's increased competitiveness following a devaluation, as it did from previous devaluations of the lira currency.

Since Germany would lose from Italy leaving, could it bribe Italy to stay in? Well, it could try, but the costs would be huge given Italy's national debt, larger than Germany's, and the Italians might not be prepared to do the things Germany would demand to keep it in.

Conclusion from these two snippets? The risks of break-up are not yet priced properly into the markets but the once unthinkable is now being thought.

Start your day with The Independent, sign up for daily news emails
PROMOTED VIDEO
News
ebooksNow available in paperback
Sport
Scunthorpe goalkeeper Sam Slocombe (left) is congratulated by winning penalty taker Miguel Llera (right)
football
Life and Style
A woman walks by a pandal art installation entitled 'Mars Mission' with the figure of an astronaut during the Durga Puja festival in Calcutta, India
techHow we’ll investigate the existence of, and maybe move in with, our alien neighbours
Arts and Entertainment
Sir Ian McKellen tempts the Cookie Monster
tvSir Ian McKellen joins the Cookie Monster for a lesson on temptation
News
i100
Travel
Tourists bask in the sun beneath the skyscrapers of Dubai
travelBritish embassy uses social media campaign to issue travel advice for festive holiday-makers in UAE
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Marketing Services Manager - (communications, testing, DM)

£32000 - £35000 per annum + benefits: Ashdown Group: Marketing Services Manage...

Guru Careers: Finance Account Manager

£Neg. (DOE) + Excellent Benefits: Guru Careers: A Finance Account Manager with...

Ashdown Group: Java Developer - Hertfordshire - £47,000 + bonus + benefits

£40000 - £470000 per annum + bonus: Ashdown Group: Java Developer / J2EE Devel...

Ashdown Group: Direct Marketing Manager - B2C, Financial Services - Slough

£45000 - £55000 per annum + Benefits: Ashdown Group: An exciting opportunity h...

Day In a Page

Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

Jeb Bush vs Hillary Clinton

Karen Tumulty explores the power dynamics of the two first families
Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

Stockholm is rivalling Silicon Valley

The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

Crucified Santa: Urban myth refuses to die

The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

The Boy in the Dress: On set with the stars

Walliams' story about a boy who goes to school in a dress will be shown this Christmas
La Famille Bélier is being touted as this year's Amelie - so why are many in the deaf community outraged by it?

Deaf community outraged by La Famille Bélier

The new film tells the story of a deaf-mute farming family and is being touted as this year's Amelie
10 best high-end laptops

10 best high-end laptops

From lightweight and zippy devices to gaming beasts, we test the latest in top-spec portable computers
Michael Carberry: ‘After such a tough time, I’m not sure I will stay in the game’

Michael Carberry: ‘After such a tough time, I’m not sure I will stay in the game’

The batsman has grown disillusioned after England’s Ashes debacle and allegations linking him to the Pietersen affair
Susie Wolff: A driving force in battle for equality behind the wheel

Susie Wolff: A driving force in battle for equality behind the wheel

The Williams driver has had plenty of doubters, but hopes she will be judged by her ability in the cockpit
Adam Gemili interview: 'No abs Adam' plans to muscle in on Usain Bolt's turf

'No abs Adam' plans to muscle in on Usain Bolt's turf

After a year touched by tragedy, Adam Gemili wants to become the sixth Briton to run a sub-10sec 100m
Calls for a military mental health 'quality mark'

Homeless Veterans campaign

Expert calls for military mental health 'quality mark'
Racton Man: Analysis shows famous skeleton was a 6ft Bronze Age superman

Meet Racton Man

Analysis shows famous skeleton was a 6ft Bronze Age superman
Garden Bridge: St Paul’s adds to £175m project’s troubled waters

Garden Bridge

St Paul’s adds to £175m project’s troubled waters
Stuff your own Christmas mouse ornament: An evening class in taxidermy with a festive feel

Stuff your own Christmas mouse ornament

An evening class in taxidermy with a festive feel
Joint Enterprise: The legal doctrine which critics say has caused hundreds of miscarriages of justice

Joint Enterprise

The legal doctrine which critics say has caused hundreds of miscarriages of justice
Freud and Eros: Love, Lust and Longing at the Freud Museum: Objects of Desire

Freud and Eros

Love, Lust and Longing at the Freud Museum