The fact that financial markets have not suffered many crashes despite the bursting of the bond bubble is a reflection of the strength of the banking system, although non-banks may be vulnerable, explains Govardhana Rangan, Bodhisatva Ganguli and MC. Joel Rebello. Edited excerpts:
Global economies are seeing what they haven’t seen for decades: recession and inflation. We have three different scenarios in China, Europe and the US. How are you reading it?
I think the biggest threat is inflation and the inability of central banks to really control inflation. When you finish reading the headlines, you think that the problem of inflation is behind us. Well, it’s not good. I mean, we know that the price of oil went up and the price of oil went down. For me, underlying wage growth, especially in the US, and labor shortages are issues. Inflation is going to be a bit more difficult to tackle than the market thinks. Which means higher interest rates for longer. And that could cause a recession that would be challenging. Then the obvious geopolitical risks. I was very encouraged by the Bali (G20) handshake. I have been encouraged by the moderating voice of people like (Indian Prime Minister Narendra) Modi in this global conflict, particularly around Russia.
What do these rising interest rates mean for banks?
We’ve had very good earnings over the last year and a half, and we’ve driven 5% to 7% growth, plus interest rates. It is interesting to read the way the market looks at banks, they will talk about the interest rate windfall. Well, it’s a windfall relative to zero, but zero isn’t normal. And zero interest rates are very difficult for banks. We feel very strongly. So, we’re back to normal. And given the intractability of inflation, it’s hard to see us going back to zero interest rates, even if we have an economic slowdown. We had a pretty severe economic contraction in 2020 through 2021, but no credit losses yet. And I think that’s a reflection, obviously, of the government’s support.
How far can rates go up?
We are closer to the top. I guess we’ll end up with a 5% Fed (US) terminal rate. That’s substantially more than we are today. But obviously, if the data changes over the next year, or a year and a half after that, we may not get there. But I still think that inflation is going to be quite difficult to bring down. I think central banks have to do a little more. Ideally, you can slow down wage growth, because I think that’s really the driver right now. You cannot slow down wage growth without slowing down the economy. And they will continue like this and there will be no relaxation. I must say that there is no need to get tough on the fiscal side. The world is still run by populism.
There is a kind of triumphalism in India at the moment. We have just become the fifth largest economy in the world, surpassing the former colonial powers. Is this triumphalism justified?
Absolutely. Directionally it is justified. I have been coming to India three or four times a year for 35 years and the alignment between the perspective of local entrepreneurs, small and medium enterprises, large companies, financial institutions, external investors, domestic investors, the government and economists have never been so consistent. Before, the beginning of each meeting was a little litany of things that go wrong. Now, the first part of the discussion is, ‘isn’t that great?’ We remained fully invested in India for many years building this business steadily. We have also had problems in India over time.
How do you see the opportunity in India?
We have a very strong business with internationally minded Indian corporations and that is becoming more and more powerful as India expands beyond borders. We have shifted our focus somewhat from being primarily a lender to a balanced lender and service provider. We have an extremely strong business with financial institutions in India, which provide a bridge to the rest of the world and also attract international financial institutions because international financial institutions are very focused on India now. We’ve always had a very strong proposition for the wealthier population, and that population is obviously growing dramatically.
When it comes to global banks, we see different models. Citi has sold its retail business to be fully wholesale, but DBS has bought a local bank. What is Standard Chartered’s strategy?
We have a wholesale business, which is structural, our strength is in the wholesale part of our business with our global network as a true differentiator. India is an extremely important part of that global network. Whether it is Indians in the diaspora or non-resident Indians running businesses or operations back home. There is the global dimension and we are taking advantage of that very strongly. While our market share in many individual markets is relatively small, the technology we can implement gives us scale in all markets. So what we lacked in scale in an individual market, we try to make up for in scale in all of our markets. And we also try to make peace through associations.
His reading is that inflation is a problem. Rates have risen too fast and a bond bubble has burst. We have seen crypto bubbles burst and problems like Archegos and Credit Suisse. What does the store have?
I think it’s amazing that we haven’t had more accidents. This is the worst year in the markets since 1972. It has been horrible in both the equity and fixed income markets. Archegos was just good old fashioned leverage. FTX was back to good old fashioned leverage. These are just poorly managed liquidity portfolios in what may or may not have been good deals. But these are small things for the global economy. And I think of the huge shadow banking system that existed in China five years ago. No accidents despite a substantial drop in property values in China. No systemic bank has gotten into trouble. Credit Suisse has not needed government support. So I think it really speaks to the actions that everyone took after the financial crisis to desensitize the core financial system to financial shocks. So we all know that the credit cycle is not dead, the credit cycle is still there. And credit cycles are quite manageable unless they are fed into the financial system.
What do events like the UK bond market crashing in a matter of a few days and then Blackstone halting withdrawals on some of its funds show? Is the system fragile?
I think there are pockets of fragility for sure. The Blackstone example is really interesting because there is still a reasonably large maturity lag in the non-bank sector. I think in the banking sector, we are very heavily regulated. The regulation is not the binding constraint on us in terms of our liquidity profile, the binding constraint is our own risk appetite. But in case we got a little crazy, the regulators would stop it. You have no regulation in a private real estate or private credit fund. And I think the Blackstone example, the experience was really healthy for the whole private fund business. Interestingly, a $4.5 billion investment went into that Blackstone fund from the California Endowment Fund. The Blackstone fund is actually a great investment vehicle, but it offered short-term liquidity on what are essentially long-term assets. And the story is played over and over again. So I think that’s the system actually working, rather than not working.
So, you don’t see a lurking crisis in the financial system?
On average, we have two or three financial crises somewhere in the world every year and one global financial crisis every nine to ten years. And then a really bad one once a generation. You get a massive shock with a pandemic and then another massive shock with wars and the effects of climate change and geopolitical tensions. And there’s almost no impact on the economy because the banking system is rock solid. The average level of bank capital in 2006 was 5.5%. 14% is the base now plus another 10% loss-absorbing capital. So it now had a 24% equity ratio relative to what was roughly 6%.
With conflicts and regional trading blocs emerging, what is happening with globalization?
Globalization is definitely not dead. It is simply acquiring new features. From our perspective, what is happening is simply fabulous. Because reshoring or nearshoring is moving out of China to markets where we actually have a larger market share. Some of it is coming to India. Yes, there are also Chinese companies investing in India, but some of that is going to Vietnam, Thailand, Malaysia, Indonesia and parts of the Middle East. And these are markets in which we have a very strong presence. Therefore, trade volumes have increased. Our cross-border investment volumes have increased, associated currency risk management has increased. We have a front row seat in this repositioning of supply chains through our trading business, but also through our investment business. Obviously, there are flaws along the way.
Indian and European regulators are in dispute over inspections of the institutions. What is your view?
Given the very important play in the Indian money markets, we are very interested in the result. We are concerned, but hopeful for a resolution.
Were you approached by First Abu Dhabi Bank for an acquisition?
No. I was looking at my computer screen. And just like that, our share price went up 20%, almost instantly. I hung up the call and wanted to know what was going on. Then I saw the Bloomberg story. My opinion on this is of course that I have not discussed with First Abu Dhabi Bank and I had no idea about this. The first thing that is quite encouraging to me is that people are starting to see that there is real value in Standard Chartered Bank. We’ve got a super clean balance sheet, we’ve got good earnings growth, we’re operating in very exciting markets. You cannot create this franchise. The second thing that is clear is that bank combinations are very complicated and particularly complicated for us because we are operating in many different markets, and each regulator has a say in these things. If anyone wants to buy from us, be my guest, but make sure you reflect the full value of this franchise.
ESG has been a hot topic. Now Fed Chairman Jerome Powell has said he won’t touch it. Is that correct?
It’s a tricky area, particularly in the US because it’s gotten political. So I don’t know what prompted the Fed chair to make these comments about regulation. But I’m assuming he’s responding to the noise in the US, which is that the US government or even private companies shouldn’t be focusing on sustainability. What motivates us to have a very clear and aggressive sustainability strategy? One is that it is the right thing to do. We operate in all the big markets in Africa, and these are the markets that are going to be destroyed. Therefore, we have a self-interest in protecting the environment.