UK Banking in 2023

With interest rates rising, Charles Davey and David Lock take a view on the current state of banking in the UK and what it means for business.

(See also our follow up article - US banks under pressure. What is going on?)

It wasn’t so long ago that we were blogging around what a strange banking world we live in….and here we are again.  

Recently, amidst the highly publicised misfortunes of Credit Suisse, Silicon Valley Bank and Signature Bank, the Bank of England raised interest rates by 0.25% to 4.25%, the 11th interest rate hike in less than 18 months and now the highest interest rate the UK has seen for 15 years.  

So this begs the question, what on earth is going on?  Are we going back to the heady days of 2008?  Will the UK banking system crash?…and more importantly, what does this all mean for business?  Lets take these in order.

Are we seeing a repeat of the 2008 financial crisis?

The bank’s Governor, Andrew Bailey, has rejected the idea of an imminent financial crisis, pointing out that the world is not in the same position as it was in 2008.  

So, do we at Bishop Fleming think we are heading for another UK banking crisis? In short, no, at least not at the moment - and the reason for this is that the bank crashes seen recently are predicated on a very different set of circumstances to those of 15 years ago. 

In 2008, the crisis was primarily caused by the collapse of the US housing market and the subsequent failure of major financial institutions that had invested heavily in US mortgage-backed securities. This led to a severe credit crunch and a sharp decline in economic activity.

The key point here is that these badly performing mortgages were packaged up as securities and sold around the world to other banks, which meant that all banks were sharing the risk on the same anonymous loans.  So when the home-owners handed the keys back, all banks were sharing the same losses.  

This was a ‘systemic’ failure

In 2023, the banks that have failed have done so due to specific problems that were facing them individually.  

Credit Suisse's woes were high-profile, long standing and reputational in nature.  We won’t reiterate them all here – suffice to say they read like the plot line of a gripping best-seller.  Their recent announcement regarding reporting irregularities was the straw that broke the camel’s back, seeing funders and depositors moving their money elsewhere and leaving a hole that couldn’t be filled.

Silicon Valley Bank, in contrast, was overly-exposed to the majority of Silicon Valley’s private equity backed start-up/technology operations.  As interest rates rose, bank lending became too expensive, so the techy customer base started to pull their deposits and use those to fund growth instead.  Again this created a hole that couldn’t be filled.

And finally, Signature was a major player in cryptocurrency….enough said

So why do we say a crisis is unlikely ‘at the moment’, as opposed to absolutely no?  

Well, unfortunately there is one underlying factor which can mean that all bets are off – and that’s ‘panic’.  No matter how large or well capitalised a UK bank is, if everyone takes an irrational view that their money might not be safe with that institution, they will want their money out (otherwise known as a ‘run on the bank’), and that bank will most likely fail.

Interest Rate Rises

We have stated that recent bank failures were down to their specific circumstances, but there is one underlying common factor that is the actual root of all problems at present – rising interest rates.

Sitting behind this are the financial problems facing the UK in 2023, which are primarily the result of broader macroeconomic factors, such as the ongoing impact of past lockdowns, a shortage of labour, and uncertainty surrounding global supply chains. These factors, along with others, have led to a slowdown in economic growth and rising inflation.

The decision to raise interest rates was driven by this inflation, which the Bank of England considers to be a bigger threat to the economy than the problems of a few banks.  The other key factor is the US – history suggests that whatever they do over there, we tend to follow suit.

The effects of interest rate hikes on banks are broadly twofold: 

• net interest income (a key element of bank profitability) is more likely to be higher on lending activity, assuming that there is still lots of lending activity – so this is good for banks; but
• the government gilt edged bonds and other fixed rate securities that banks invest in will go down in value, leaving balance sheets weaker – this is bad

Unfortunately for some, the former is being outweighed by the latter, and this is the exact issue that Silicon Valley Bank witnessed.  As depositors withdrew funds to invest in projects, the bank needed money, so the bank sold its bonds, but the bonds had gone down in value, so the bank made losses, which meant that the bank needed more money…..

The Bank of England is very much alive to these issues and so, at the same time as hiking interest, has also brought in new measures, including:

• a tightening up of rules on money-market funds to withstand the risk of sudden investor withdrawals;
• urging financial firms to improve their operational resilience; and
• retaining a rainy-day buffer to help banks absorb losses.

These actions in the UK come as regulators around the world are similarly strengthening their financial systems.

The UK Economy

So, the financial problems facing the UK in 2023 are not the same as those that led to the 2008 crunch.

While there are certainly challenges facing the UK economy, there are also many reasons to be optimistic about its future.

First, the UK banking system in 2023 is in a much stronger position than it was in 2008. Following the financial crisis, the UK government implemented a series of reforms designed to strengthen institutions and prevent a similar crisis from occurring in the future.

These reforms included new regulations on banks and financial institutions, as well as measures to improve financial stability and reduce systemic risk.  As a result, UK banking is much more resilient than it was in 2008, being better capitalised, with higher levels of reserves and more robust risk management systems in place. 

Another important difference is the global economic context.

In 2008, the crisis was part of a wider global economic downturn, with many countries experiencing sharp declines in economic activity and rising unemployment. This made it difficult for governments to implement coordinated policy responses, and contributed to the severity of the crisis.

In contrast, the global economic context in 2023 is much more favourable. While there are certainly challenges, such as rising geopolitical tensions and trade disputes, overall economic growth, although subdued, is strong in sectors such as business services where consumer demand is more resilient, and many countries are experiencing low levels of unemployment.

This provides a more supportive backdrop for the UK economy and makes it easier for the government to implement policies to support growth, should the current Chancellor wish.

Finally, it is worth noting that the UK economy in 2023 is much more diverse than it was in 2008. In the years following the financial crisis, the UK government made a concerted effort to diversify the economy and reduce its reliance on the financial sector. This has led to the growth of new industries, such as technology and renewable energy, which are less vulnerable to shocks.

The BoE's decision to raise interest rates also reflects its confidence in the UK economy's ability to weather current challenges and maintain stable economic growth.

Impact on businesses

So, taking all of the above into account, how is the current UK banking market likely to impact your business?  

We would suggest that this is quite a complex question, with a number of multi-dimensional answers depending on: the size, stability and performance of your business, which sector you are in, whether you are a borrower or cash rich, and whether you are looking to buy or sell.

For companies with high levels of variable rate debt, the interest rate hike is probably not good news.  These businesses will see an increase in their borrowing costs, which could put a strain on their cash flow and limit their ability to invest in new projects or expand their operations. 

To counter these debt pressures, companies do actually have a range of actions that they can take.  

For instance, changes can be made to the trading and operation model, including reducing costs, raising prices, working smarter, budgeting better, dropping marginal customers/projects, negotiating harder, changing suppliers etc.

Another option is to look at the debt itself, and this is where a good advisory and banking relationship really pays dividends.  If presented correctly, existing debt can be re-termed, reduced, restructured or hedged.  Early discussions with banks are always the best route – no one likes a last minute surprise. 

Finally, one can consider alternative funding options, such as replacing debt with equity – again, a good advisor can guide you through this.

On a more positive note, companies with strong cash liquidity can benefit from the interest rate hike.  The most direct reward is earning higher returns on their cash reserves, with banks really incentivising those that can lock their deposits away for 90 days or more.

There are also more M&A opportunities for acquisitive companies as they target financially vulnerable businesses which are struggling to pay debt.  Often these are perfectly good, profitable businesses with skilled staff and commercially viable business models – their only mistake was to over-leverage themselves in the good times when debt was cheap.

It is also important to note that the impact of rising UK interest rates will vary, depending on the industry and size of the company. Large multinational corporations with diverse global operations and multiple funding sources will likely be less affected than small and medium-sized enterprises that rely purely on domestic borrowing.

Conclusion

It is clear that 2023 is not 2008. The circumstances are different, and lessons have been learned in the banking and financial services sectors, with greater resilience to economic disruption.  In the absence of irrational panic, the UK banking system should hold up

Arguably, had the Bank of England had the foresight to raise interest rates much sooner than it did, rates would not have risen so quickly and both banks and companies would have had more opportunity to adapt – but decisions were made in the context of many complex factors.  

Whilst there may be a further rise this year, inflation is on a downward trend with falling energy costs and by the end of 2023, rates may have plateaued, with a growing case for cutting them.

For those companies who are in the position to do so, this is a good time to invest in the business with new plant and machinery (using the Spring Budget’s new Full Expensing relief) and potentially increasing M&A activity.  For those with debt issues, options are available – you are not alone.  

In either case, this is the time to talk to your advisors to take advantage of or adapt to this rather strange market.

Further information

If you would like to discuss how we can help your business, please contact Charles, David or a member of our Funding Advisory team.