Trends and breakdown of UK FIRE-based (red and pink) and COCO-based (blue) lending (£bn)(Source: BoE; CMMP)
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.
Trends in the breakdown of UK sterling lending since 2002 (% total) (Source: BoE; CMMP)
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.
…Subdued (EA) and slowing (UK) demand for consumer credit
The key chart
Quarterly consumer credit flows as a multiple of pre-pandemic average flows (Source: BoE; ECB; CMMP)
The key message
The ECB and Bank of England are expected to deliver 50bp rate increases today (2 February 2023) in the face of relatively subdued (euro area) and slowing (UK) demand for consumer credit.
Both regions have experienced seven consecutive quarters of positive demand for consumer credit since 1Q21 (see key chart above). Euro area (EA) demand has remain relatively subdued, however, and has failed to recover to pre-pandemic levels. Quarterly consumer credit flows, for example, ended 2022 at €5.0bn, only 0.5x the pre-pandemic average of €10.3bn. UK consumer credit demand hit £4.4bn in 2Q22 (1.2x the pre-pandemic average flow of £3.6bn) but slowed to £2.8bn in 4Q22 (0.8x the pre-pandemic average flow).
This matters for two reasons:
First, increased borrowing is one way that EA and UK households can offset the pressures from falling real disposable incomes (along with reduced savings);
Second, consumer credit is the second most important element of productive COCO-based lending, after corporate credit. It supports productive enterprise since it drives demand for goods and services, hence helping corporates to generate sales, profit and wages.
The EA and UK money sectors are both sending clear messages of slowing demand for consumer credit and mortgages. The contrast with the US is interesting – the FED is slowing the pace of rate increases to 25bp despite the fact that US consumer credit flows remain well above their pre-pandemic levels.
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
Synchronised slowdowns in monthly UK and EA mortgage flows are accelerating
The key chart
Monthly mortgage flows (3m MVA) as a multiple of pre-pandemic average flows (Source: BoE; ECB; CMMP)
The key message
Current trends in the euro area (EA) and UK mortgage markets provide little cheer for investors hoping for a growth recovery in the regions.
The synchronised slowdown highlighted last month accelerated further in December 2022. Monthly mortgage flows have fallen below their respective pre-pandemic averages in both cases. The rate of slowdown is particularly sharp in the EA.
Given that mortgage demand typically displays a co-incident relationship with real GDP, the message from the UK and EA money sectors is one of rising risks to the economic outlook – the challenging context for central bank decisions this week.
Monthly mortgage flows – the key trends
Monthly mortgage flows have fallen below their pre-pandemic levels in both regions (see key chart above). The 3m MVA of monthly mortgage flows in the EA (€7.2bn) has fallen to only 0.58x the pre-pandemic flow (€12.5bn). In the UK, the 3m MVA of mortgage flows (£3.7bn) fell to 0.95x the pre-pandemic flow (£3.9bn). This was the first time that the UK’s monthly mortgage flow has fallen below its pre-pandemic average since December 2021.
The rate of slowdown in mortgage lending flows is particularly sharp in the EA. Flows have fallen from €26bn in June 2022 (2.02x pre-pandemic average) to €7bn in December 2022 (0.58x pre-pandemic average). This compares with respective multiples of 1.32x (June) and 0.95x (December) for UK mortgage flows.
Monthly mortgage flows – the UK details
Monthly mortgage flows (£bn) and annual growth rate in outstanding stock (RHS) (Source: BoE; CMMP)
Monthly UK mortgage flows fell to 3.2bn in December 2022 down from £4.3bn in November 2022 (see chart above). December’s flow was only 0.83x the pre-pandemic average flow of £3.9bn and below the recent March 2022 peak of £7.5bn (1.9x pre-pandemic flows).
Approvals for house purchase, and indicator of future borrowing, decreased to 35,600 in December 2022 from 46,200 in November. The latest approvals were the lowest since May 2022 and represent the fourth consecutive month of declines. It is reasonable, therefore, to expect lower UK flows in coming months.
Monthly mortgage flows – the EA details
Monthly EA mortgage flows (EUR bn) and annual growth rate in outstanding stock (RHS) (Source: ECB; CMMP)
Monthly EA mortgage flows fell to €4.5bn in December 2022 from €8.9bn in November and €30.1bn in June 2022 (see chart above). December’s flow was only 0.4x the pre-pandemic average of €12.6bn and was the lowest monthly flow since March 2020 (€3.8bn) at the start of the pandemic.
Monthly mortgage flows – why the slowdown matters
Given that mortgage demand typically displays a co-incident relationship with real GDP, the message from the UK and EA money sectors is one of rising risks to the economic outlook – the challenging context for central bank decisions this week.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Positive 2022 euro area PSC trends proved unsustainable in 4Q22
The key chart
Trends in PSC (% YoY) and contribution (ppt) of COCO-based lending (Source: ECB; CMMP)
The key message
The positive private sector credit (PSC) dynamics that supported a more optimistic outlook for euro area (EA) economic activity proved unsustainable in 4Q22.
The context for this week’s ECB policy announcement remains a challenging one with coincident and lagging monetary indicators slowing sharply.
The “Coco is cooling” at the start of the new year…
Is the Coco cooling?
PSC dynamics supported a more optimistic outlook for EA economic activity through 2022. PSC growth accelerated and productive COCO-based lending made an increasing contribution to this growth (see key chart above). A recovery in corporate (NFC) credit demand led this process. Both factors were positive for the EA growth outlook. Unfortunately, neither proved sustainable in 4Q22.
PSC growth peaked at 6.7% YoY in September. At this point COCO-based and less-productive, FIRE-based lending both contributed 3.3ppt to total PSC growth. By the end of 4Q22, PSC growth had slowed to 5.0% YoY, with the COCO-based and FIRE-based lending contributing 2.4ppt and 2.7ppt respectively. The key driver here was the peaking of NFC credit, the largest segment of COCO-based lending. NFC credit growth has slowed from 8.1% in October 2022 to 5.5% in December 2022.
Trends (EUR bn) and breakdown (% total) of euro area PSC since 2004 (Source: ECB; CMMP)
Recall that unorthodox monetary policy (QE) had fuelled the wrong type of lending in the EA. At the time of the GFC, the outstanding stock of COCO-based lending peaked at €5,517bn in January 2009, and contributed 55% of total PSC. This level was not reached again until December 2021. At this point COCO-based lending contributed only 48% of total PSC. In other words, nearly all of the aggregate growth in EA lending between these dates was in the form of lending to support capital gains through rising asset prices (see chart above). This explains why last year’s dynamics were so important – demand for productive lending was recovering again.
Unfortunately, annual growth rates in mortgages (the largest contributor to FIRE-based lending) and NFC credit (the largest contributor to COCO-based lending) fell -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart below).
Trends in real M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
As noted in my previous post, these variables typically display coincident and lagging relationships with real GDP growth. Both are suggesting rising risks to the economic outlook in the euro area. This is the context for the latest policy announcement from the ECB on Thursday.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Atypical foundations for a bull market in European equities
The key chart
Trends in YoY growth rates in real M1, real HH credit and real NFC credit (Source: ECB; CMMP)
The key message
Monetary developments in the euro area (EA) present atypical foundations for a bull market in European equities.
The good news is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Two (of three) key signals from the money sector suggesting a normalisation of economic activity.
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. This matters because these three variables (real M1, HH credit and NFC credit) typically display leading, co-incident and lagging relationships with real GDP over time. If historic relationships continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
The key question for asset allocators, therefore, is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?
Cold water therapy or cold shower?
Trends in broad (M3) and narrow (M1) money (% YoY, nominal terms) (Source: ECB; CMMP)
Monetary developments in the EA present atypical foundations for a bull market in European equities. Growth in broad money (M3) fell to 4.1% in December 2022, down from 4.8% in November 2022. This represents the slowest rate of growth since January 2019 (see chart above). Growth in narrow money (M1) slowed sharply to 0.6% in December 2022, down from 2.4% in November 2022. This represents the slowest rate of growth since August 2008. At the same time, the SXXE index closed at 449.17 on Friday 27 January 2023, up 26% from its early 4Q22 low.
Growth rate in M3 (% YoY) and contributions from ON deposits and other sources (ppt) (Source: ECB; CMMP)
The good news from the money sector is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Recall that cash hoarding by HHs and NFCs in the form of overnight deposits was the key driver of the rapid expansion in broad money during the pandemic – a combination of forced and precautionary savings (see light blue columns in the chart above).
In the 4Q22, the flow of HH deposits fell to €26bn, the lowest quarterly flow since the pandemic began and well below the 2Q20 peak of €190bn and the pre-pandemic average flow of €91bn (see chart above). Recall also that a moderation in HH deposit flows was one of our three key signals for a normalisation of economic activity post-COVID. A second was a re-synching of money and credit cycles (see below).
Trends in M3 and PSC (% YoY) (Source: ECB; CMMP)
Money and credit cycles have been desynchronised for much of the past decade, creating major challenges for policy makers, banks and investors alike. The gap between the growth in money supply and the growth in private sector credit (PSC) hit a historic high during the COVID-pandemic (see chart above). As the region emerged from the pandemic, these growth rates have converged as the build-up in excess savings has slowed and the demand for credit has recovered (at least in nominal terms). A positive sign.
Trends in M3 and PSC (% YoY) since December 2017 (Source: ECB; CMMP)
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. Growth in adjusted PSC, for example, slowed to 5.3% in December 2022, down from 6.2% in November 2022 and down from the recent September 2022 peak of 7.0% (see chart above).
Trends in monthly mortgage flows (EUR bn) (Source: ECB; CMMP)
The monthly flow of mortgages, for example, fell to €4.5bn in December 2022, down from €8.9bn in November 2022 and down from the recent peak of €30.1bn in June 2022. The latest monthly flow was the lowest recorded since March 2020 (see chart above). The YoY growth rate in mortgages also fell to 4.4% in December 2020 down from 5.8% YoY in August 2021.
Monthly consumer credit flows also remain subdued in absolute terms and in relation to trends seen in the US and the UK. The monthly flow fell to €0.5bn in December 2022 from €2.1bn in November 2022 and €2.4bn in October 2022. As noted in “Clues from consumer credit”, the risks to EA economic growth lie more in the lack of demand for consumer credit and on-going household uncertainty.
Trends in real M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP over time. Each indicator has peaked and is falling in real terms – -7.9% YoY, -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart above). If historic relationships between these variables continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
In short, the key question for asset allocators is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Assessing the state of the US consumer balance sheet
The key chart
Trends in the stock of US consumer credit ($tr) and the consumer credit to DPI ratio (%) (Source: FED; CMMP)
The key message
What are the implications of buoyant US consumer credit flows for the state of household balance sheets?
Consumer credit is the second largest financial liability for US households (24% total) after mortgages (64% total). This structure has changed little over the past 20 years, although the relative importance of mortgages (up then down) and consumer credit (down then up) fluctuated in the interim period.
Consumer credit displays a relatively stable relationship with disposable personal income (DPI). The recent moderation in monthly credit flows is consistent with the consumer credit to DPI ratio being at high end of its narrow, historic range (at the end of 3Q22).
Mortgage debt, in contrast, displays a more volatile relationship with DPI. Importantly, the deleveraging of the US HH sector in the post-GFC period is due almost exclusively to a reduction in excess mortgage indebtedness. Consumer credit indebtedness is largely unchanged.
Two key messages here:
It is reasonable to assume that the demand for consumer credit will continue to moderate, putting pressure on consumption in the process
Overall HH sector risks associated with the level of indebtedness and affordability of debt remain more manageable than in the pre-GFC period
Recall that the US led advanced economies in the structural shift away from relatively high-risk HH debt towards relatively low-risk public debt in the post-GFC period.
More elevated HH debt risks can be found elsewhere…
Risky US consumer credit dynamics?
In my previous post, I noted that US consumers were doing their level best to counter the “US slowdown” narrative. While consumer credit demand has moderated from its recent highs, monthly flows in November 2022 were still almost double their pre-pandemic average flow. In response, I was asked what this means for the state of consumer balance sheets. This post provides a summary response.
How important is consumer credit?
Trends in stock of consumer credit broken down by type (Source: FED; CMMP)
Consumer credit is the second largest financial liability for US households (24% total), after mortgage debt (64% total). The structure of financial liabilities has changed little over the past 20 years, although there has been important variations in the relative importance of mortgages (up then down) and consumer credit (down then up) during the interim period (see charts above and below).
Structure of US consumer credit (% total) over past 20 years (Source: FED; CMMP)
What is the relationship with disposable personal income?
Trend in consumer credit / disposable personal income ratio (%) (Source: FED; CMMP)
Consumer credit has also displayed a relative stable relationship with disposable personal income (DPI) over this period. The recent moderation in demand is consistent with the fact that the ratio was close to the upper end of its historic range at the end of 3Q22 (see chart above).
Trends in HH credit / disposable personable income ratio by type (Source: FED; CMMP)
Mortgage demand, in contrast, has displayed a more volatile relationship with DPI over the period (see chart above). Indeed, the deleveraging of the HH sector in the post-GFC period is due almost exclusively to a reduction in mortgage indebtedness (see chart below). Consumer credit indebtedness is largely unchanged since the GFC.
Trends in HH credit / disposable personable income ratio by type (Source: FED; CMMP)
Conclusion
Two key messages here:
It is reasonable to assume that the demand for consumer credit will continue to moderate, putting pressure on consumption in the process
Overall HH sector risks associated with the level of indebtedness and affordability of debt remain more manageable than in the pre-GFC period
Recall that the US led advanced economies in the structural shift away from relatively high-risk HH debt towards relatively low-risk public debt in the post-GFC period.
More elevated HH debt risks can be found elsewhere…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Christmas Spirit is still alive in the UK, if slightly muted
The key chart
Trends in UK card payments versus pre-pandemic levels (Source: ONS; CMMP)
The key message
The message from the UK money sector is that the “Christmas Spirit” is very much alive, albeit in a slightly muted fashion compared to last year.
Monthly and weekly credit and debit card payments show increased activity in line with expected, pre-Christmas trends. Aggregate spending increased 5ppt from 101% of pre-pandemic levels (PPLs) in October 2022 to 106% PPLs in November 2022. On a weekly basis, aggregate spending rose 13ppt from 108% to 121% in the week to 1 December 2022.
Change (ppt) in monthly credit and debit card payments (Source: ONS; CMMP)Change (ppt) in weekly credit and debit card payments (Source: ONS; CMMP)
The largest increases in spending were on so-called “delayable” items (including Christmas presents?). They rose by 14ppt on a monthly basis from 86% PPLs in October 2022 to 100% PPLs in November 2022 and by 22ppt on a weekly basis from 107% PPLs to 129% PPLs.
Again, these developments are in-line with expected, pre-Christmas trends. They are also supported by personal, anecdotal evidence of walking through a teeming Westfield Shopping Centre in Stratford, London yesterday on way to the highly recommended “ABBA Voyage” concert!
While aggregate card payments are up slightly on a YoY basis (2ppt), spending on delayable items is lower. Monthly and weekly payments on delayable items are down by 6ppt and 8ppt respectively over the past year. This is not surprising given the re-allocation of UK spending towards “work-related” and “staples” as a result of the impact of rising inflation on fuel, energy and food prices etc.
In short, inflation has dampened Christmas spirit in the UK, but it has not killed it off!
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Seven reasons why China dominates global debt dynamics (in charts)
The key chart
Trends in private sector credit (US$ tr) (Source: BIS; CMMP)
The key message
In this final “Update required” post, I consider China’s private sector dynamics (post-2Q16) and the exposure of the banking sector to these dynamics (see, “Update required – Part III”). I highlight seven reasons why China dominates global debt dynamics today and illustrate them graphically.
China has the largest outstanding stock of private sector debt globally ($39tr)
China’s market share of private sector debt has increased to 27% from 20% in 2Q16 (and only 6% in 2Q08)
In the process, China has eclipsed the “EM-debt” story – the share of EM ex-China has remained unchanged over the period
China’s debt dynamic has shifted from excess growth in corporate debt (well-known) to excess growth in household debt (less well-known)
The fact that the rate of growth matters, not just its level, is the first important lesson here
The second is that affordability matters – China’s private sector debt service ratio is elevated in absolute terms and against historical trends
With recent re-intermediation, the banking sector is relatively exposed to the risks associated with current debt dynamics. Bank sector debt ratios exceed the levels reached at the height of the Spanish private sector debt bubble, for example
Why China dominates global debt dynamics in charts
Chart 1: Size
Top-ten BIS reporting economies ranked by stock of private sector credit (US$ tr) (Source: BIS; CMMP)
Chart 2: Market share
China’s share of total private sector, corporate (NFC) and household (HH) debt (% total) (Source: BIS; CMMP)
Chart 3: Eclipsing the rest of EM
Breakdown of global private sector by region (% total) (Source: BIS; CMMP)
Chart 4: Shifting debt dynamics
Trends in relative growth factors – 3Y CAGR in PSC versus 3Y CAGR in GDP (Source: BIS; CMMP)
Chart 5: Rising affordability risks
Selected debt service ratios – deviation from 10Y average (ppt) plotted against 2Q22 level (%) (Source: BIS; CMMP)
Chart 6: Re-intermediation…
Bank credit as %age of total private sector credit (Source: BIS; CMMP)
Chart 7: How exposed is the banking sector?
Comparison of PS and bank sector debt ratios – Spain versus China (Source: BIS; CMMP)
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
How exposed are banking sectors to elevated private sector credit risks?
The key chart
Trends in selected bank credit ratios (% GDP) (Source: BIS; CMMP)
The key message
How exposed are banking sectors to elevated private sector debt risks in Sweden, France, Korea, China and Canada?
Recall that these five economies have private sector debt ratios that exceed the “peak-bubble” level seen in Japan in 4Q94 and debt service ratios that are not only high in absolute terms but are also elevated in relation to their respective 10-year, average affordability levels. Twin warning signs.
The banking sectors in China and Korea have the highest exposures to elevated private sector debt risks among this sample (see key chart above):
China: bank credit accounts for 84% of total private sector credit and the bank credit ratio of 184% GDP exceeds the peak-Spanish bank credit ratio of 168% GDP;
Korea: bank credit accounts for 73% of total private sector credit. The bank credit ratio of 161% GDP is slightly below the peak-Spain level but well above the peak-Japan level of 112%.
Selected private sector credit ratios (% GDP) broken down by bank and non-bank credit (Source: BIS; CMMP)
In contrast, risks in Sweden, France and Canada are shared more equally between banks and investors (see chart above). Bank sector credit accounts for 51%, 50% and 49% of total private sector credit in Sweden, Canada and France respectively (reflecting the greater development of alternative sources of credit in advanced economies).
This does not mean that banks are not exposed, however. The bank credit ratio in Sweden is 138% GDP, above the peak-Japan level. In France and Canada these ratios are the same or slightly below the peak-Japan level (112% GDP and 109% GDP respectively).
In short, risks remain real and elevated. In a world, that sees public sector debt as a problem but largely ignores private sector debt, this matters, or at least it should do…
Please note that the comments and charts above are abstracts from more detailed research that is available separately.
Trends in bank credit to the private non-financial sector in Japan, Spain and China (% GDP) (Source: BIS; CMMP)
The key message
This is the second chart from 2017 that needs updating. It follows directly from the first chart that illustrated how China was following in the footsteps of Japan and Spain in terms of private sector debt dynamics (see “Update required – Part I”).
The purpose of the second chart was to contrast the exposure of Spanish and Chinese banks to private sector indebtedness with the exposure of Japanese banks at the time of the Japanese debt bubble in the 1990s. It illustrated trends in bank credit to the private non-financial sector expressed as a percentage of GDP.
Trends in Japanese PS debt ratio (% GDP) and Bank credit to PS ratio (% GDP) (Source: BIS; CMMP)
Japanese private sector indebtedness peaked in 4Q94 at 214% GDP. At the time, bank credit was 112% GDP, or 52% of total private sector debt. In other words, banks and investors largely shared Japanese private sector debt risks equally (see chart above).
In contrast, when Spanish private sector indebtedness peaked at 227% in 2Q10, bank credit was 168% GDP, or 74% of total private sector debt (see chart below).
Trends in Spanish and Chinese PS debt ratios (% GDP) and Bank credit to PS ratios (% GDP) (Source: BIS; CMMP)
When I first published the chart above, Chinese private sector indebtedness was 202% of GDP. Bank credit was 157% GDP, or 77% of total private sector debt (see chart above).
In short, Spanish and Chinese banks were more exposed to excess private sector indebtedness than their Japanese peers had been before them. This reflected not only the relatively high level of indebtedness, but also the relatively important roles played by Spanish and Chinese banks in terms of the supply of credit to the private sector.
This leads to two obvious questions:
What has happened to China’s private sector debt dynamics subsequently and how exposed is the banking sector today?
How exposed are the Swedish, French, Korean and Canadian banking sectors to the elevated private sector indebtedness levels, highlighted in “Update required – Part II”?
