Are we too complacent about the chances of a banking crisis? Jézabel Couppey-Soubeyran, Erica Perego and Fabien Tripier have written on the subject for EconPol Europe (the European network for economic and fiscal policy research).
It is a sobering read.
They reckon the non-repayment of one in five loans would be sufficient to cancel out current levels of capital, and judge that the bank resolution mechanism would be “unlikely to be sufficient”. This type of doomsday scenario is more likely if the crisis lasts beyond this year — hardly implausible.
They also draw out some of the dilemmas facing regulators. One is the extent to which they should allow banks to eat up capital buffers in order to incentivise lending, at the expense of making those banks more vulnerable to losses.
Another is about transparency: should supervisors inform the market regularly about how healthy banks are? On the one hand, this risks panicking customers and investors. On the other, investors and customers may not be reassured by a lack of information anyway.
Unfortunately, the researchers stay sat on the fence: “The tension between the risk of panic associated with transparency on the one hand and the risk of uncertainty and surprise associated with opacity on the other makes it very difficult to reach a clear-cut opinion on the matter.”
However, they think European authorities have chosen opacity, with the European Banking Authority postponing the stress test until next year, for example.
On the topic of the length of the crisis, Keith Wade, chief economist and strategist at Schroders, writes how his firm has gone from predicting a V-shaped to a U shaped recovery.
They expect the rebound to be weaker for four reasons: difficulties in lifting lockdowns; cautious consumers, for example in the travel, hospitality and leisure sectors; rollback in fiscal support; and dampened business investment.
Moving to the issue of sustainability, Legal and General Investment Management has done some research into how important environmental, social and governance (ESG) factors are to savers.
“People who were nonplussed by the term ‘ESG’, came alive when we discussed the underlying themes in terms they connected with: ‘climate change’, ‘human exploitation’, and ‘fair pay’,” said Emma Douglas, head of DC (defined contribution).
Fitting with general perceptions, more than twice as many baby boomers as millennials would prioritise investment performance over climate considerations.
However, not all the findings showed millennials as keener on ESG. When asked, “if you knew your pension was invested in companies that have attracted criticism for their governance and pay practices, what would you prefer to do?” millennials were more likely to say they would to remain invested.
As for the effect of gender, nearly twice as many men as women put performance first on environmental topics, but L&G said “social impact themes resonated more with men than women.”
Something very relevant to ESG, and thrust into the spotlight recently, is racial inequality. Adam Levitin, a professor at Georgetown Law, writes in The American Prospect about one way racial discrimination plays out in the US mortgage market.
Fannie Mae and Freddie Mac charge loan-level pricing adjustments (LLPAs) to lenders who sell them mortgages, as required since 2007 by the Federal Housing Finance Agency. The LLPA is based on the borrower’s credit score, mortgage type, and down payment, and can increase the interest rate by as much as 3.75%. Data suggests the LLPA cost is passed straight on to the borrower.
“LLPAs may appear race-neutral, but their structure compounds existing racial wealth disparities,” says Levitin. “Because LLPAs are higher for low-down-payment mortgages, they fall more heavily on borrowers with less savings for a down payment. And because LLPAs are more costly for borrowers with worse credit scores, they fall disproportionately on those with low and moderate incomes, who are in turn disproportionately minorities.
“This creates a vicious circle: because of the racial wealth gap, LLPAs are more likely to exacerbate the racial homeownership gap, which further reinforces the racial wealth gap.”
While LLPAs were designed to protect Fannie and Freddie from weakened underwriting standards, he says that changes in the securitization market mean they are “a solution to a problem that no longer exists.”