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.

 

RELATED ARTICLES

Reality bites

Is 'The Great Australian Dream' a sham?

A world out of sync with inflation

banner

Most viewed in recent weeks

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Latest Updates

Investment strategies

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Planning

Super, death and taxes – time to rethink your estate plans?

The $3 million super tax has many rethinking their super strategies, especially issues of wealth transfer on death. This reviews the taxes on super benefits and offers investment alternatives.

Taxation

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Shares

The megatrend you simply cannot ignore

Markets are reassessing the impact of AI, with initial euphoria giving way to growing scepticism. This shift is evident in the performance of ASX-listed AI beneficiaries, creating potential opportunities.

Gold

Is this the real reason for gold's surge past $3,000?

Concerns over the US fiscal position seem to have overtaken geopolitics and interest rates as the biggest tailwind for gold prices. Even if a debt crisis doesn't seem likely, there could be more support on the way.

Exchange traded products

Is now the time to invest in small caps?

With further RBA rate cuts forecast this year, small caps may be key beneficiaries. There are quality small cap LICs and LITs trading at discounts to net assets, offering opportunities for astute investors.

Strategy

Welcome to the grey war

Forget speculation about a future US-China conflict - it's already happening. Through cyberwarfare and propaganda, China is waging a grey war designed to weaken democracies without firing a single shot.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
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.