Various effects of ?financial isolationism? take hold By Tony Jackson
Financial Times Published: January 25 2009 15:26
One of the big dangers facing the world economy is ?financial isolationism?, Gordon Brown, UK prime minister, told this newspaper. This is the growing tendency for German banks to lend only to Germans, American banks to Americans and ? yes ? British banks to the British.
That started even before the latest wave of bank nationalisation, which will doubtless make things worse. It appears that those worrying about trade protectionism have been looking in the wrong place. The more immediate threat is capital protectionism.
In economic terms, the potential harm is obvious. In any one country, if savers and borrowers cannot be brought together the economy suffers. The same is true of saver and borrower nations globally.
The less obvious threat is to multinational corporations. If they can only borrow in their country of origin, they must change the way they finance themselves. This is starting to happen already.
Let us remind ourselves how capital protectionism works. On one level, individual banks draw in their horns to control their risk.
There are stories circulating of US and Japanese banks slashing the number of corporate customers they are targeting in Europe. And when a syndicated loan to a company comes up for renewal, there is a marked tendency for foreign members of the syndicate to bow out.
The other level is political. Whatever the risk of beggar-my-neighbour policies, there are powerful motives for governments to direct the banks they control.
Suppose a state-controlled British bank faces a choice of lending to a UK company for a new plant in the UK or for an acquisition in Mexico. The first protects UK jobs and boosts the tax base, the second does neither. No choice. In the days before globalisation, the company could ? and normally would ? borrow directly in Mexico. Today, it is less likely that a foreign company would have that kind of relationship with a local bank, and still less likely it would have a standby facility to allow for prompt action.
So how can companies address this? The most obvious way is through the bond markets, thus bypassing the banks entirely ? disintermediating, in the jargon.
Developed world bond markets are certainly opening to an extent ? but only to the safest companies and on expensive terms. Government moves to buy up corporate debt may help, but we shall see.
The next obvious step is what Graham Secker of Morgan Stanley calls ?re-equitisation?. This, as he says, comes in three forms.
The main one is share issues. In the UK, at any rate, there has been a creeping barrage lately from companies and their advisers, aimed at softening up investors before the big push. Success hangs on the state of the equity market ? hardly propitious right now. And as with bond issuance, success also hangs on not needing the money too badly in the first place.
Failing that, the dividend can be slashed, thus directly boosting shareholders? funds. The last resort is the debt-equity swap, of which several are no doubt in the pipeline.
A further intriguing option is suggested by David Bowers of Absolute Strategy Research. In the 1970s, he points out, the big money was made not by banks, but by financiers ? the likes of the UK?s Lord Hanson.
These financiers typically made their money through conglomerates. The trick was to set up a central business which threw off lots of cash, then allocate that cash around the rest of the empire. As a means of bypassing the banks, the conglomerates could be due for a comeback.
The 1970s parallel is taken further by John Grout of the UK?s Association of Corporate Treasurers. When he started his career in the early 1970s, big companies relied on the bond markets for long-term borrowing and used the banks only to fund their short-term working capital.
In the UK, that changed in the mid-1970s when the US banks started pushing large syndicated loans. Big companies became more dependent on the banks and the average duration of their borrowing shortened.
Now, he says, that should go into reverse. When possible, companies will issue bonds, thus borrowing longer again. Short-term finance will be shunned as risky and by choice will be done through the money markets and commercial paper ? when those markets revive ? rather than through overdrafts.
Companies will hold much more cash ? both on prudential grounds and as a means of funding short-term opportunities. That will also, of course, allow them to shunt money around the world as needed.
So in the long run, banks should be able to shrink their balance sheets to their hearts? content, at least as far as their corporate customers are concerned. Whether they will be able to expand them again when this is all over is another question.