Bank crises not responsible for recession, argues policymaker

Since the financial crisis, the Bank has been granted wide-ranging powers to regulate the banking industry in addition to setting monetary policy.

But in their paper, Weale and co-author Bank economist Matthew Corder suggest that the links between the health of the real economy and that of banks are not as clear-cut as sometimes assumed. Looking back at the past 30 years of economic history in 14 developed countries including Britain, the United States and Japan, Weale identified only high current account deficits as a common risk factor for bank crises which are followed by recessions.

“Monetary inflows that accompany deficits may enable banks to expand credit excessively, while potentially exposing them to volatile international wholesale markets. Such excess lending may lead to an overheating economy and unsustainable rises in asset prices,” Weale and Corder said.

However, separate factors were usually at play on the more frequent occasions when either a bank crisis or a recession occurred on its own. Low bank capital ratios and a high amount of lending relative to the size of the economy were also good warning signs for a bank crisis, but changes in the economic cycle and property and share prices were not, they wrote.

By contrast, falling property and share prices often did foreshadow a recession, as did a downturn in the OECD’s leading indicator for economic growth, the researchers concluded. Bank capital ratios and credit growth had little predictive power.

They said that economists were still a long way from being able to reliably predict recessions and banking crises, in part because of the difficulty of accurately modelling banks’ overseas exposures.