Economic crisis (2): And the winner is...the banks!

If high inflation lasts too long and the cost of living rises significantly, employees will sooner or later demand more pay from their employers - to compensate for inflation. This sets off the wage-price spiral, because companies pass on the higher wage costs to prices - which fuels inflation. From the basic economics course we know that a central bank has to intervene here and raise key interest rates to push inflation down. This can work if the economy is strong enough. But if the economy is not strong enough, there is a danger of recession. That is what we are witnessing right now. So why this interest rate policy, that's a good question!

In August 2023, the ECB's key interest rate for medium-term loans will rise from 4% to 4.25%. Real estate loan interest rates will thus remain at a high level, while savings interest rates will only rise slowly. In Switzerland, people are already massively worried about the key interest rate increases. This is because the interest rate policy is not only hitting the weakening economy, it is also having the effect of accelerating the cost of living, especially rents. Now, tenants are already under pressure due to sharp increases in energy costs. The cost of living will become even more expensive, and for a longer period of time. So the ECB is becoming a reliable inflation driver with its interest rate policy. Why is that?

Golden times
Swiss economist Rudolf Strahm puts his finger on the right spot in a commentary on the central banks' interest rate hikes: "What is the hidden agenda? Is it merely the proverbial inflation paranoia of monetary orthodoxy? Or is it to help the banking sector make a profit after the negative interest rate phase?"[1]

Because the winner of this whole scenario is - we are not surprised - the financial sector! Strahm says: "The massive increase in bank profits of 20 to 30% (in some cases even 40%) in the first half of the year, thanks to the high interest margins, points to this intention. In addition, the Swiss National Bank financed the banks with CHF 3.3 billion in the first half of the year with the increased interest on the cash holdings deposited with it. These are implicit subsidies! They are currently enabling the windfall profits of the banks."[2]

And this trend is not only happening in Switzerland, it is happening all over Europe. The higher interest rates increase the profitability of the banks, the average return on equity is already a comfortable 10.4%.[3] Wherever you look, only success stories: UniCredit closes the first half of 2023 with a record profit of €4.4 billion. In the second quarter alone, the major Milanese bank posts a profit of €2.3 billion, exceeding expectations. Deutsche Bank posts a pre-tax profit of 3.3 billion euros in the first half of 2023, its best result since 2011.[4] Hooray!

However, not only Europe's, also America's big banks are earning significantly more from lending. At the same time, they hardly pass on the increased interest rates to savers. JP Morgan's net interest income is $21.8 billion at the end of June - a record and the third peak in a row.[5] The world's largest asset manager Blackrock can also cheer. Adjusted profits rose by a quarter to 1.4 billion dollars in the second quarter.[6]

A topsy-turvy world
How paradoxical this development is can be easily illustrated by the example of Croatia: The Croatian Central Bank declared on 29 August that the operations of credit institutions generated a profit of 703.8 million euros in the first half of 2023, compared to 413 million euros in the period January to June 2022.[7] Thanks to the euro and rising interest rates, money is being made strongly here.

Let us contrast this jubilant news with the following: In Croatia, the inflation rate is currently just under 8%, food and services are on average 15 to 20% more expensive than a year ago - and thus before the introduction of the euro. 70% of Croatian exports go to the EU, and tourism is the most important sector of the economy, accounting for about 20% of GDP. If tourism collapses, it will trigger an additional massive economic crisis. We only need to look back 15 years and calculate what the financial crisis triggered in tourism countries like Spain or Greece.

Croatia suffers from excessive bureaucracy, an inefficient judicial system and widespread corruption. The trade deficit is large, as is the foreign debt. Croatia has about 4 million inhabitants. Almost as many Croats live and work abroad.

The main thing is that the banks are doing well!

But, what was that again? The banks had to be saved with taxpayers' money, didn't they?

This analysis was first published in: Le Courrier des Stratèges on September 11th, 2023

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