The return of rampant inflation and geopolitics resembles a rerun of a shoddy 1970s B-movie. It certainly has regulators worried, and should concern global bank CEOs as well. By Justin Pugsley.
What is happening?
“We are living in a totally new era,” the former US secretary of state Henry Kissinger declared in an interview with the Financial Times. That much was spelled out in the International Monetary Fund’s (IMF’s) latest financial stability report and speeches by its president Kristalina Georgieva, which sound like a roll call of the Four Horsemen of the Apocalypse. All the bases were covered: death, destruction, pestilence and famine.
It warned about a looming food crises in developing countries, the ongoing Covid-19 pandemic, the war in Ukraine, rising US interest rates and economic reversals. This implies more geopolitical instability globally, with the Horsemen barely breaking into a trot — never mind galloping.
Not to be outdone, the Financial Stability Board chipped in with some dire warnings of its own, particularly around bank exposures to commodities and cyber threats.
This is all happening amid geopolitical tensions between the West and Russia/China, suggesting that globalisation as we know it is over. Eventually, this could even impact global rule-making for the big banks, potentially creating even more regulatory fragmentation.
Why is it happening?
Soaring inflation and the unpicking of the global order is the result of many complex factors. Before Russia was cut off from most of the global economy, there were already problems brewing in the commodities complex. Investor demands for dividends and the green lobby successfully persuading energy groups to curb new exploration is one factor.
S&P Global noted that the oil majors’ exploration budgets plummeted from $525bn in 2019 to $341bn in 2021, implying lower future output. Some of that spending was switched into renewables, which are not yet ready to replace hydrocarbons.
Western efforts to wean themselves off Russian oil and gas will also prove inflationary as there are no obvious fast replacements. Nor can all that energy simply flow to China and India instead, with pipelines being in the wrong places for that to happen.
There are pressures across the entire commodity sector, including agriculture. There are three main types of fertiliser used in crops: nitrogen, phosphorus and potassium. All are in short supply, with nitrogen being made from natural gas. Much more expensive fertiliser will mean less use and therefore lower crop yields. No wonder the IMF is so worried about a looming food crisis. The troubles in Sri Lanka might soon become more commonplace.
Then the repatriation of supply chains closer to home will undermine the benefits of specialisation and the economies of scale, and will also drive up costs.
What do the bankers say?
For the big global banks, the end of globalisation is terrible news as it potentially erects new hurdles to the international capital flows they benefit from. Due to Western sanctions and public opinion, half a dozen Western banks are already having to walk away from their Russian subsidiaries.
But perhaps the biggest victim among the global banks could end up being HSBC. Its business model is based around bridging China and the West, which looks increasingly untenable in an era of intensifying geopolitical rivalry between the two blocs. It has already had several uncomfortable run-ins with US and Chinese authorities making conflicting demands. Now one of its leading shareholders, the Chinese insurance giant Ping An, is arguing for the bank to be broken up along the lines of a ‘China-friendly’ Asian bank and a ‘US-friendly’ one.
Will it provide the incentives?
Regulators are acutely aware of the new global environment and are taking a keener interest in bank risk management practices. They do not want the benefits of a decade’s worth of tough global financial reforms to be swept away by poor risk practices.
However, there could be some silver linings hiding in a very gloomy outlook. The best cure for high commodity prices is higher prices. It incentivises new production while rationing demand.
Technology and automation, which tend to be deflationary, will help lower costs, and there is a new incentive for entrepreneurs to innovate to reduce costs. Nimble banks can play a role in financing these changes.
The West looks more united than it has done in decades, which bodes well for closer co-operation around issues such as trade and possibly regulation. Also, the Ukraine war will eventually end, which will take some heat off commodity supply chains. Depending on how it turns out, it might even deter other countries from invading their neighbours.
