UK banks cutting back on overseas lending, shifting focus on domestic market

Banks in the UK are cutting back on lending overseas at the fastest rate in the world, as they begin to shift focus on the domestic market, says Bank of England policymaker Kristin Forbes. The domestic market refers to suppliers and consumers within a country’s borders, which in the UK means the internal British market.

Forbes, a member of the Bank of England’s interest-rate setting monetary policy committee, said that “home bias” has been on the rise since the economic crisis, with the UK setting the leading role in the “deglobalisation” of banking.

At Queen Mary University in London, Forbes said:

“The contraction in UK international lending and borrowing is larger – on an absolute basis – than for any other country for which data is available. In other words, the decline in bank flows into and out of the UK has contributed more to the global decline in banking flows than any other country.”

Since its peak the UK’s cross-border financial exposure has dropped by 23% back to levels in late 2007.

Governments urged a focus on domestic lending when banks were bailed out at the height of the financial crisis, which is a possible explanation for the decline in international banking flows.

In 2011, well after the bailout of Royal Bank of Scotland in 2008, George Osborne said:

“We believe RBS’s future is as a major UK bank, with the majority of its business in the UK and in personal, SME [small and medium-sized enterprises] and corporate banking. Investment banking will continue to support RBS’s corporate lending business but RBS will make further significant reductions in the investment bank, scaling back riskier activities that are heavy users of capital or funding.”

Another explanation for the decline in international banking flows includes weaker balance sheets after the economic crisis and a drop in the demand for loans.

Forbes said that if the UK’s banking system is less globalised then it increases the country’s vulnerability to domestic economic problems, however, it also decreases the UK’s exposure to economic shocks that occur abroad.

“Although a deglobalised banking system may increase the correlation between domestic lending and domestic shocks, it could simultaneously reduce the correlation with foreign shocks,”

“The reduction in cross-border exposure, especially when combined with the lower levels of leverage and stronger balance sheets, should substantially increase the resilience of UK banks to foreign shocks.”

She noted that a decline in international banking flows could make it harder to fund the country’s account deficit.

“A reduction in international bank flows could make it more difficult, and possibly even more expensive, for the UK to fund its current account deficit.”