Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 501

A banking crisis is here, the credit crunch may be next

There is a banking crisis playing out at the moment. On its own, it is unlikely to create major issues, but the credit crunch following the banking crisis will create the major issues.

This time is different

Dangerous words, I know. But this time has already been different. 

Banking crises usually evolve from a wave of defaults as economies slow and corporates go bankrupt. Then investors get worried about bank solvency and start pulling their money from banks. The next step is a credit crunch which makes the situation worse. Banks swimming in capital a few months earlier find themselves abandoned by investors and deposits hard to come by.

In response, banks scale back on their own lending. At the same time, they lift credit standards, only loaning to the better quality corporates. This is known as a credit crunch.

A credit crunch has the effect of making things worse. Corporations find credit hard to come by and expensive, leading to more defaults. And this is usually when we get a banking crisis. After the credit crunch, not before. 

Three paths forward

A credit crunch is not inevitable. Let's group the possibilities into: bull, bear and base cases. 

Bull case

This is the most optimistic. It relies on a 'whatever it takes' type of speech from the US central bank. There are lots of different forms this could take. Basically, it needs to keep credit flowing to the corporates. The problem is if central banks do this, they will effectively be stomping on the brake and accelerator at the same time. 

Central banks are trying to slow credit down. They are raising interest rates to slow credit growth, slow economic activity and therefore bring inflation back under control.

If they go all out quickly and in a big way, they are torpedoing the inflation goal. The bull case is not impossible. But it seems unlikely.

Bear case 

In this scenario, the banking crisis is allowed to get out of control, such as if Credit Suisse had been allowed to fall over. Or, the next major bank that runs into trouble is allowed to fall. It is the consequence of markets chasing from one questionable bank to the next to the next. Allowed to run unchecked, a full-blown, 2008-style financial crisis would occur.

But it is highly unlikely. Generals are usually good at fighting the last war. For central banks, preventing a re-run of the 2008 Financial Crisis is very high on the list of priorities.

Base case 

Central banks and regulators do enough to prevent a financial crisis. They continue to bail out and help banks where possible, but they fall short of a broad 'whatever it takes' approach. 

What does that mean? 

Bank funding costs increase. Deposits flee the smaller banks. Both have already started. 

As a consequence, banks scale back their lending. Interest rates charged are higher. Corporates bear the brunt, the US falls into recession and default rates spike. Inflation is no longer a concern. Central banks can now roll out the big guns.

Net effect: a mini-banking crisis, followed by a credit crunch, possibly followed by a traditional banking crisis. Bad for stocks, good for government bonds, not pretty for corporate bonds. 

What to watch for

The key question from here is which of the three cases is most likely, and how we are going to know which one is happening.

First, we look at surveys of credit availability. Bank officer surveys already suggest that banks were restricting credit before the latest round of bank bailouts. Some purchasing manager surveys show the same thing, but from the point of view of the corporate. 

Talking to companies directly about the issue is probably only of limited value. Companies do not want to advertise problems with funding. 

The more reliable data comes later. Credit growth data will be important. Probably not as important as early indications of bankruptcy statistics. 

Funding costs are important. Credit default swaps on banks and corporate bond spreads are two of a host of indicators. 

Where to hide

Which investments will be safe in this environment? Government bonds will be the key beneficiary of the base or bear case. Corporate bonds give a higher yield but capital loss is the danger.  

Cash will be an attractive option, but if you are over the deposit guarantee limits, choose a larger bank. In Australia, it is highly likely governments will step in and bail out depositors for a large bank.  

From a country perspective, you might need to be more nimble as most regions have their own issues:

  • US regional banks have structural reasons to be the epicentre (more loans, more concentrated deposits, more exposure to commercial property, low reserves). 
  • However, the European Central Bank has a reputation for being late when it is time to start rescuing. So Europe is not without its risks as well.
  • Australian stocks are typically a leveraged play on world growth. If world growth tanks, then the same will likely be true for Australian stocks. And Australia has a much larger banking sector relative to most other markets.

From a sector perspective, you want defensive stocks and high-quality stocks, but which stocks are truly defensive? Commercial real estate is looking a little dicey, so REITs, often considered defensive, are more at risk than other defensive sectors. Energy utilities and infrastructure can have structural issues as they transition away from (suddenly cheaper) fossil fuels, so pick carefully. 

High-quality stocks are those with high margins, low debt and good returns on capital invested. Over the last year, because of inflation, every company has been able to increase prices. The question is which companies can hold on to those price increases as demand tanks, and which will have to return the price rises. Oligopoly sectors, or those with low levels of competition, will be more likely to hold onto the price rises. Sectors with lots of players or competition are significantly more at risk.

Value is not going to save investors during this downturn. It is not the type of recession where value outperforms. This type of recession is where valuation gets hit quite hard because earnings in these value stocks will be more at risk.

Picking up a great company at a decent price 

Just as importantly, you want to have a shopping list of high-quality companies that you always wanted to buy but were too expensive. There is a good chance you will be able to pick them up at a discount. 


Damien Klassen is the Chief Investment Officer at Nucleus Wealth. This article is general information and does not consider the circumstances of any investor.



A world out of sync with inflation

Don't panic, this isn't 2008

Pivoting from high inflation to global recession


Most viewed in recent weeks

Australians unprepared for $3.5 trillion wealth transfer

A new report suggests that Australians are ill prepared for the largest intergenerational wealth handover in history. It's estimated $3.5 trillion in assets will be transferred from Baby Boomers to their children by 2050.

Welcome to Firstlinks Edition 534 with weekend update

Many people in the Firstlinks community have been reading my articles and editorials for 10 years or more, and worked with me for decades before that, and deserve an explanation for why I have suddenly stopped writing each week.

  • 9 November 2023

18 rules for ageing well

The rules to age successfully include, 'the unexamined life lasts longer', 'change no more than one-eighth of your life at a time', 'nobody is thinking about you', and 'pursue virtue but don’t sweat it'.

Why the ASX 200 has gone nowhere in 16 years

The ASX 200 is around the same price that it was 16 years ago. The poor long-term performance can be largely blamed on our taxation system, which encourages companies to pay out most of their earnings as dividends.

The challenges of building a lazy portfolio

John Bogle famously advocated a two-fund portfolio of US stocks and bonds. Recently, I tried to create an Australian version of the Bogle portfolio and found that what seems simple can quickly turn complicated.

SAPTO and LITO, or do you really need an SMSF?

Money withdrawn from super after age 60 is tax-free but less understood are arrangements that allows a couple over the age of 67 to earn up to $57,948 per year outside super and pay no tax with LITO and SAPTO.

Latest Updates

Investment strategies

Two proven ways to make big money in markets

Many ASX success stories – like JB Hi-Fi, Lovisa, and AUB – have followed one of two strategies: rolling out single store formats nationwide or consolidating fragmented industries. Here are the secrets behind these business models.

Investment strategies

The bank is still a terrible place to put your money

With the RBA having lifted interest rates by 4.25% over 18 months, many investors now see cash as an attractive investment option. That ignores the silent tax of inflation, which makes other assets better investment alternatives.

Little to fear from APRA's hybrids review

APRA's objections to hybrids are misplaced. If the regulator wants more safety in our banking system, it will come at the expense of effectiveness, and that's why wholesale changes to the hybrid market are unlikely.

Investment strategies

Rates higher = shares lower… is it that simple?

Typically, higher interest rates are associated with lower share market valuations, but not always and the relationship hasn’t been that strong over the long term. Company fundamentals will matter more over the next few years.

Investment strategies

Diversification is not a free lunch

Harry Markowitz said that “diversification is the only free lunch in investing” as holding a broader range of assets can result in better returns without assuming more risk. This has become accepted wisdom - but it isn't true.


Why Asia remains one of the world's best growth stories

China’s economic slowdown and the resilience of the US dollar have dimmed the lustre of many Asian economies’ strong growth momentum in the past year. But heading into 2024, Asia's growth story should reignite.

Podcast: Property picks, PE update, and Warnes on Michelle Bullock

Charter Hall's Steven Bennett talks through commercial property's challenges and opportunities, Schroders' Rainer Ender on private equity's bright spots, and Peter Warnes on how RBA hawkishness will impact rates and the economy.



© 2023 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.