‘Money-printing spree has turned banks into drug addicts’

Waves of money printing have turned banks into “drug addicts” reliant on cheap cash to stay afloat, one of the world’s top central bankers has warned.

Raghuram Rajan, who was once a contender to lead the Bank of England, said repeated rounds of quantitative easing (QE) had encouraged lenders to take bigger risks in search of returns that are disappearing in the world of higher interest rates.

The former head of India’s central bank said “excessively aggressive monetary policy” was ultimately to blame for the collapse of Silicon Valley Bank in the US, which had billions of dollars tied up in long-term bonds.

More than a decade of low rates and money printing have made commercial banks reliant on the “drug of stimulus” that will lead to more failures as central banks continue to tighten policy, Mr Rajan warned.

“High QE has made the banking system more dependent on central bank liquidity,” he told the Telegraph in an interview.

“And when you try to withdraw it very quickly, you find it’s like a drug addict. It’s gotten used to the drug. And you can’t provide the old levels of the drug because they’ve gotten used to new high levels. And so it seizes up when you do that.

“I think we have to go back to asking, ‘why did these systemic risks emerge?’ And almost always the root cause of these systemic risks is monetary policy.”

The former chief economist of the International Monetary Fund (IMF) warned the banking crisis was far from over, predicting that lenders holding long-term debt and those who before the pandemic invested in commercial property and office buildings will suffer the most.

“We will see more bankruptcies,” he said.

Mr Rajan blamed the current turmoil facing the First Republic, which is fighting for survival, on its holdings of “jumbo mortgages” issued when interest rates were at rock bottom.

Worried customers pulled $100bn (£80bn) in deposits from the bank in March amid fears that the bank was sitting on big losses.

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The Federal Deposit Insurance Corporation (FDIC), which is responsible for overseeing depositor protection in the US of up to $250,000 for savers, has warned that US banks are sitting on more than $620bn of paper losses due to the rise in interest rates.

Academics at NYU Stern School of Business believe the figure could be as high as $1.7 trillion, which is “comparable to the total equity in the entire banking system.”

Mr Rajan said the FDIC’s estimate did not take into account losses from all long-term debt, as he warned of a potential reckoning .

“So there are losses from long term loans, but there’s also the commercial real estate losses to buildings to office buildings, which nobody wants to come into nowadays,” he added.

“So rents are going to fall. Valuations are gonna fall for those buildings. So I’m not saying there’s a huge crisis on the way, but I’m saying there’s enough to be concerned about.”

The 60 year-old, who was one of the few economists who correctly predicted the 2008 financial crisis, said a decade of benign inflation combined with low interest rates had led policymakers and some economists to falsely believe they could “stimulate to high heaven” during the pandemic without pushing up prices.

He said attempts by policymakers in the UK, US, eurozone and Japan to “goose up” inflation had created an environment where “borrowing was very easy”, leading some to believe there was “no cost to spending”, which had spurred the rise of populist theories including modern monetary theory. “And politicians love that,” he added.

Flooding the world with trillions of pounds of cash led banks to “eat up that liquidity” by issuing riskier lines of credit, Mr Rajan said. Higher interest rates meant cheap money was now starting to evaporate, which would spell trouble for both banks and businesses.

Now a professor of finance at the Booth School of Business at the University of Chicago, the economist said central banks were in danger of doing more harm than good because they were trying to “do too much”. Mr Rajan, who has himself been described as a “rockstar” central banker, said the public had come to expect policymakers to keep rates low to support economic growth.

“My prescription has always been ‘don’t try to do too much’. Don’t think you have these magnificent weapons which will deal with all problems. And don’t think that you can solve every one of society’s problems,” he said. “Because the more you claim to be superhuman, the more people will expect. And the harder the fall will be when they find out you really can’t fix them.”

He warned that advanced economies could not ignore the very warnings they often forced developing nations to follow. He said many were avoiding the tough reforms usually handed out by the IMF to countries in need of financial rescue.

“We’re trying to solve too many problems that have emerged in the industrial West with stimulus, when in fact the IMF prescription for emerging market countries with the same problems would be called structural reforms,” he said.

He warned that the current troubles facing the banking sector could not automatically be solved by more regulation.

Global regulators are examining if smaller banks, which cannot raise cash in financial markets in the same way as their larger counterparts, need to hold more capital or greater depositor protection.

But Mr Rajan said: “The big question with all this regulation coming down the line on these small and medium banks is what happened to the old regulations? Duration [interest rate] risk is one of the first things a supervisor looks at. We used to look at it regularly in India and say, let’s reduce that risk. So if you don’t enforce existing regulations, what’s the point of new ones?”

He warned against blanket guarantees which he said would encourage more risk taking. “I think [the failure in 2008 of] Lehman Brothers has burned people so much that they don’t want even one failure. The problem with that is, regulators are sending the message that they will be there to bail you out, whenever.

“Every time you rescue, you make it even clearer that you will be around to rescue the system once again.”

Mr Rajan suggested that it was a mistake for central banks, including the Bank of England, to start selling their stockpile of government bonds amid the rapid increase in interest rates.

The Bank announced it will offload £80bn of government debt back to the market this year. It also said last week that taxpayers were potentially on the hook for £200bn in losses over the next 10 years, more than wiping out the £120bn in profits during a decade of quantitative easing.

“There is a notion [from the central banks] that [selling bonds] is like watching paint dry. It’s a boring process, it will be without risk. And I’m saying we don’t know what the risks are in the shrinking process. So given that already raising rates is a risky process, it’s better to put this on the shelf and deal with this down the line.”

Mr Rajan admits that he was “approached” to be the next Bank of England governor before Mark Carney left the job in 2020, but did not apply.

He describes the job as a “very political position”, adding: “It’s not that I shy away from a challenge. But I have to know that I can do a good job. And my sense is, given the politics of a particular situation, the last thing you want to introduce is another dimension of ‘this guy’s from another country. Does he understand what we’re about’?

“How much pain can you inflict? What would the consequences be? That’s a political decision. It’s made by unelected officials. But it requires understanding what the tolerance levels might be.”

He also knows all too well what the consequences are of pushing too hard. His abrupt decision to leave the Reserve Bank of India in 2016 came after growing political disquiet over the RBI’s decision to keep interest rates high to quell inflation.

While Mr Rajan insists he was “plenty popular” with the public, he offers a brief insight of life at the top – and why he’s staying away from policymaking for now. “It can get ugly very quickly.”