By Fadi Halout | 2 May 2023
The recent increase in interest rates acted as a wake-up call for borrowers and lenders across the globe. Too many young investors get used to nil value for time! We are facing at present an increase at unprecedented pace. For example, European central Bank deposit rate went up from minus 0.5% last July 2022 to 3% in March 2023.
Addiction to cheap money
Regulators will do whatever it takes to avoid inflation destroying the economy. The same regulators however underestimated the risks of rising interest rates on few lenders. Financial institutions are definitely more resilient since the subprime crisis in 2008, but some of them were addicted to cheap money and unable to manage their balance sheet wisely.
Banks to face new stringent rules
Banks were supposed to benefit from such new “normal” environment where time has a value. Negative rates are an absolute anomaly! Deluge of money were fueled into fake investment opportunities and ghost companies. The SPAC phenomenon is just an example, when money was given to someone without knowing where it is going to be invested, when and why!
Central Banks reacted rapidly to prevent risks spreading among the global banking sector. The good news is that lessons are being taken quickly and more stringent rules will apply to lenders, no matter what their size is.
Back to basics for asset allocation
On the borrower’s side, the cost of leverage will be much higher. Not all investment returns will be higher than the cost of debt. Therefore, the level of debt to be used has to be assessed carefully, especially in the real estate market.
This new area of strong inflation and higher rates is not so new. It is an eye opener for all stakeholders, borrowers, lenders but also regulators, that time has a real value, and need to be factored into investment decisions. Basic considerations such as cash flow, real business plans and economic rationale are back into the spotlight. And this is no doubt good news for asset allocation choices.
