For years the conventional thinking was that economies where banking assets fell below the level of GDP were emerging whereas economies with banking assets two or three times the size of GDP were acknowledged as advanced. That was before the crisis.
For years, the conventional thinking was that economies in which banking assets fell below the level of gross domestic product (GDP) were emerging whereas economies with banking assets two or three times the size of GDP were acknowledged as advanced.
That was before the crisis. Then it was brought home that economies with outsized banking assets relative to their economic weight could find themselves in trouble if things went wrong in the financial sector – think Iceland, Ireland and the UK. The stark choice was between letting the banks fail or bailing them out with state resources which, in the worst cases, has saddled not only the current generation of taxpayers with the bill but the next one too.
Now, as the global economy is largely back on a growth track, the vexed question of how large a country’s banking assets should be has again raised itself. The Banker has put together some numbers for the two key economies of China and the US, which shows that China has banking assets twice the size of GDP. Whether this is a problem or not depends on the quality of the assets. But there’s the rub. Asset quality can change quite fast and a meltdown in the property sector can quickly turn seemingly good assets into bad ones.
At the same time, the old adage still stands that an economy without a plentiful supply of credit is unable to grow.
How should governments deal with this from a policy point of view? Countries in which finance is an export industry, such as the UK and Switzerland, have particular problems which the former has attempted to deal with by ring-fencing domestic assets and the latter by employing extremely high capital ratios – the so-called Swiss finish.
For everybody else, twice GDP seems to be a sensible working number, with questions to be asked any time assets are growing abnormally fast and approaching a higher ratio. This also means taking the politically difficult decision of slowing the economy down when credit is expanding too quickly. Unfortunately, there are very few successful examples of this.
Yet, unless governments can start to get to grips with macro-prudential measures, we are merely sailing along to the next crisis and no amount of Basel-style individual bank regulation can prevent it.
