According to a recent analysis by Oxford Economics on bank liquidity issues, the recent banking crisis is expected to have a dampening effect on global growth, but it does not signal an impending financial crisis—at least not yet. Although global liquidity is not as tight as it was 14 years ago, the research firm warns that banks could still suffer substantial losses due to their exposure to commercial real estate.
It’s Not 2008, But It’s Not Risk Free Either
Oxford Economics emphasizes that a bank failure does not necessarily trigger a systemic banking crisis, as safeguards are in place to mitigate risk fallout, and recent events have demonstrated their effectiveness. Although banks have failed both before and after 2008, this does not necessarily lead to a global crisis every time. While recent bank failures may seem reminiscent of 2008, Oxford Economics and many other experts argue that the current situation is different.
While both crises share a lack of liquidity as a root cause, the current crisis is distinct due to its lower levels of leverage. According to Adam Slater, lead economist at Oxford Economics, this will provide institutions with more flexibility to navigate the issue, avoiding system-wide disruption. However, while leverage is not at an extreme level that would threaten the entire system, it remains elevated above typical levels, indicating that the situation should not be taken lightly.
Despite the absence of a global financial crisis, a recession can still cause significant harm. Losses may lead to de-risking and a subsequent tightening of credit markets. Furthermore, high levels of inflation add additional pressure, preventing central banks from injecting cheap money into the market to create excess demand, as this would contribute to further inflation. Therefore, it is up to central bankers to decide between the economic hit caused by a credit contraction or rising inflation.
Regardless of which option they choose, Adam Slater of Oxford Economics predicts a “serious” obstacle to growth. The research firm had already forecasted minimal global economic growth for this year before the crisis, but now they anticipate even lower growth with risks favoring a downside scenario.
Banks May Get Stuck With Losses From Falling Asset Values, Especially Commercial Property
The risks of shadow banking, declining asset values, and commercial real estate loom large, according to a recent report. The report cautions that shadow bank exposure has not yet been fully assessed. As for asset values, Slater’s firm warns that banks may be sitting on unrealized losses equivalent to 3% of their assets. Moreover, with commercial property down 15%, banks face significant exposure.
For instance, US banks are estimated to have $4.5 trillion in loan and CMBS exposure, in addition to further exposure through short-term lending to non-bank lenders. Commercial real estate has taken a beating recently, not solely due to work-from-home issues. While the number of mortgage defaults is not high, their size poses a challenge to the GDP of small countries. Slater cites examples like the PIMCO-controlled $1.7 billion Columbia Property Trust default, Lloyds Bank’s sale of a defaulted property at 40% below its 2014 purchase price, and Blackstone’s $563 million default in Europe as massive default cases.
The world’s largest institutions playing defense leaves little room for growth potential. Once again, not every bank failure indicates an impending financial crisis, but a recession can still wreak significant damage.
