“After two decades of fuelling the FIRE…”

The key chart

After two decades of fuelling FIRE-based lending, is it time to ask, “what is the purpose of UK banking?”

Bank lending falls into two categories: lending that supports capital gains largely through higher asset prices (FIRE-based); and lending that supports production and income formation, i.e. productive enterprise (COCO-based). The former includes mortgage or real estate lending and lending to NBFIs. The latter includes corporate lending and consumer credit.

Twenty years ago, less productive FIRE-based lending accounted for 67% of M4L, the Bank of England’s headline credit series. Today it accounts for 78%. The contribution of mortgages, the largest component of FIRE-based lending, has risen from 47% to 53% over the period. This means that nearly 80 pence in every pound lent by UK MFIs finances transactions in pre-existing assets (real estate) or in financial assets. Note that mortgages are the only component of M4L to register a record high at the end of 2022.

In contrast, only just over 20 pence in every pound lent in the UK finances productive enterprise. The contribution of lending to corporates, the largest component of productive COCO-based lending has fallen from 20% to 17% over the past two decades. Note that this lending supports sales revenues, wages, profits and economic expansion. Lending that increases debt in the economy BUT critically also increases the income required to finance it. The outstanding stock of sterling loans to UK corporates at the end of 2022 (£445bn) was £61bn or 12% lower than its peak (£516bn) recorded in August 2008.

Lending in any economy involves a balance between these different forms. A key point here is that the shift from COCO-based lending to FIRE-based lending as seen in the UK reflects different borrower motivations and different levels of risks to financial stability. This has negative implications for leverage, growth, financial stability and income inequality.

Classifying lending according to its productive purpose tells us what the purpose of UK banking is today – largely to support capital gains rather than production and (direct) income formation.

The obvious follow-on question is, “what should it be?”

Please note that the summary comments and charts above are abstracts from more detailed research that is available separately.