Tag: Centralbanks

Are we Staring at a FED-instigated credit crunch?

On By mehranmuslimiblogIn UncategorizedLeave a comment

A credit crunch occurs when banks significantly reduce their lending to individuals and businesses, resulting in less economic growth because people are unable to borrow as much. Typically, banks reduce their lending when central banks raise interest rates. This is because banks borrow money based on short-term interest rates set by the central bank and lend out money based on longer-term interest rates determined by the free market. When long-term interest rates are high, banks make more profit. The larger the difference between short-term and long-term interest rates, the greater the bank’s profit. Consequently, a decrease in lending leads to an economic contraction, potentially causing a recession. It is worth noting that the yield curve inversion has been deepening since 2022.

The Federal Reserve (Fed) plays a crucial role in influencing banks and financial institutions. Its monetary policies can be stringent, which has a ripple effect on banks and financial bodies. Recently, the Fed raised interest rates, making loans more expensive. The Federal Reserve justified this action due to high inflation concerns.

Despite the Fed increasing interest rates, banks have continued to lend to individuals and businesses even though these loans are not profitable for them. Market participants are forward-looking and anticipate that the Federal Reserve will soon start lowering interest rates in response to the situation. The expectation is that lower short-term interest rates will turn the loans recently made by banks back into profitable ventures. However, this assumption depends on individuals not withdrawing their funds from their accounts due to perceived solvency problems. Banks rely on money from depositors to provide loans, and if all depositors simultaneously attempt to withdraw their money, it can lead to a bank collapse, as seen in the case of Silicon Valley Bank.

Prior to the pandemic, US banks were required to maintain 10% of funds, but since March 2020, the balance has been zero. Furthermore, banks have also suffered from a decline in asset value due to rising interest rates, leaving them with insufficient funds to sustain withdrawals. These factors contribute to the emergence of a banking crisis.

Effects of banking crisis

People are moving money from small and medium banks into big banks. This is because big banks are perceived to be too big to fail and have a guarantee of the federal reserve.

People have started scrutinizing the balance sheets of their banks. Any bank that comes across as weak has seen its stock sell off.

People with lots of money have started moving it into Investments that earn a higher interest rate than their savings accounts. This includes various forms of U.S government debt and money market funds which invest in U.S government debt.

The reason why the interest rates on savings accounts remain so low at most banks is because raising these interest rates would eat into their profits.

When the Federal Reserve System started raising the interest rates, big banks reported losing 500 billion dollars in deposits since the start of 2023. FED data suggests that total bank deposits have fallen by more than a trillion dollars since last year. Just a week after the first bank collapsed, the deposits in the money market fund increased by $120 billion.

Small banks stand at a higher risk as they are competing with deposits made to Treasury bonds and money market funds, which at the moment give more returns.Small and medium-sized banks and small and medium-sized businesses are the ones that are going to feel the credit crunch the most.

Credit crisis

A credit crisis happens when banks don’t trust the safe collateral they’re using for loans.

If small and medium-sized banks reduce their lending to small and medium-sized businesses, then they will have a harder time finding new clients and could lose existing ones. This would lower customer deposits, which would reduce lending even more causing yet more deposit flight. Small and medium-sized banks would have to sell their assets leading to a credit crisis.

Both credit crunch and credit crisis are affected by the high interest rates set by FED. If inflation comes down fast then the FED will lower interest rates and there will be no credit crunch or credit crisis if inflation stays high however then we will see a credit crunch in the second half of the year.

The current situation reflects elements of a potential FED-instigated credit crunch, with banks reducing lending, individuals moving funds to larger banks, and small businesses facing the highest risk. The outcome will depend on the Federal Reserve’s response to inflation and whether interest rates are lowered.

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Challenger banks are on the rise

On By mehranmuslimiblogIn Banks, Business, Economy, GovernmentsLeave a comment

Image result for banks

Challenger banks, neobanks, whatever you want to call them, have been making significant in-roads in the banking sector and are attracting large chunks of venture capital investment says KPMG. There are some subtle differences between the two: challenger banks are often established firms that compete with larger financial institutions, while neobanks tend to be completely digital and favour operating via mobile devices, but the difference between them is somewhat blurred. What they do share in common is this: “these banks don’t carry the weight of legacy technology, so they can leapfrog over traditional infrastructure and disrupt the status quo.”

Two of the most prominent – Monzo and Atom Bank—raised $93 million and $140 million respectively last year. Starling Bank, which is ‘digital-only’ is raising a further $54 million in a new funding round. These are all British startups by the way.

Why are so many challenger banks British?

The chief reason for the fact that so many challenger banks are UK-based is this: Britain isn’t as saturated with big banks and their branches as the US, so there is more opportunity for non-traditional financial institutions. Furthermore, the UK was an early adopter of digital banking, dating back to the dotcom era of the late 1990s and early 2000s. Basically, the UK has had a head start in this financial area, although it would be a mistake to think that challenger banks are a UK-only phenomenon.

Challenger banks worldwide

There are currently about 100 challenger banks worldwide: Brazil has Banco Original and Nubank, while Germany is home to SolarisBank and N26 and in Asia there is MyBank, WeBank, Timo, Jibun, K Bank and Kakao.

What advantage do challenger banks have?

They don’t have a legacy system and because most of them don’t offer a full suite of banking services they don’t have to operate within such tough regulatory environments. This means they have more freedom and flexibility, which in turn allows them to develop their customer base faster, especially in developing countries where bank branches are more rare than in the west.

What services do challenger banks offer?

Their focus is usually on niche products rather than trying to provide all the services that the big banks provide. For example, customers can open a current account with a relatively high rate of return and get loans, but they may have to go elsewhere for services such as credit cards, mortgages and wealth management. Some of the challenger banks do have banking licences, although not all follow this model.

Although challenger banks are on the rise, the old guard hasn’t disappeared just yet, and the traditional banks are aware of the threat the challengers pose and are preparing for battle. The traditional banks have the advantage of a large and well-establish customer base and strong branding that promotes trust. The challenger banks will have to earn trust. That will most likely come from the millennial generation over the next decade, because they are the group that have lost trust in the banks their parents use, and this is the audience that challenger banks will need to court if they are to become an established sector in banking.