Though size can be important, it is the resilience of a banking system that is key for financial stability, notes a Bank of England report.
In a report co-authored by Oliver Bush of Bank of England titled: “Why is the UK banking system so big and is that a problem?”, the authors discuss whether banking system size is a robust leading indicator of a crisis.
UK Banks’ total assets constitute 450% of nominal GDP
The Bank of England report notes the UK banking system is large relative to most other major economies. The report highlights three key features of the UK banking system.
First, the UK banking system is big. When compared to a sample of countries comprising the U.S., Japan and the ten largest European Union countries, the UK has the largest banking sector on a residency basis. Moreover, over the past 40 years the size of the UK banking system has undergone a dramatic shift, with total assets rising from around 100% to around 450% of nominal GDP.
Secondly, the report highlights that foreign banks constitute around half of UK banking sector assets on a residency basis, with the combined assets of the largest ten foreign subsidiaries in the UK (including their non-deposit-taking entities) totaling around £2.75 trillion.
Thirdly, as can be deduced from the above diagram, the non-loan assets constitute a high proportion of total UK banking assets, with only around half of UK-owned banks’ assets being loans to non-bank borrowers.
Whether banking system size a robust indicator of crisis?
Oliver Bush et al then turn their attention to the relationship between banking system size and financial stability outcomes. For this purpose, they drew on the experiences of different countries between 2005 and 2012.
The report notes establishing empirically whether banking system size is a leading indicator of banking crises is not straightforward. The authors considered using regression analysis to test whether the countries that experienced systemic banking crisis tended to have larger banking systems. The following table summarizes results from two sets of regressions using two measures of financial crisis:
As evidenced from the above results, the authors note that countries that avoided systemic banking crisis (column (1)) and had higher market-based leverage ratios (column (3)) did tend to have significantly smaller banking systems.
The authors of the report also investigate whether it is possible that economies with larger banking systems experienced weaker economic growth following the crisis. The authors note columns (1) and (2) of the following table use a measure of post-crisis output performance – the difference between average output growth in 2008-12 and in 2000-07.
The authors highlight that the coefficient on banking system size is not significantly different from zero in these regressions, so this calls into question the importance of banking system size in explaining countries’ post-crisis output performance.
The Bank of England report concludes that the resilience, rather than the size, of a banking system is the key factor in terms of financial stability. Moreover, the authors highlight that evidence from regressions and case studies suggests that less resilient banking systems are more likely to suffer a financial crisis.