The Long and the Short of It

Changes in the federal funds rate ripple through financial markets and the economy. They have knock-on effects on the interest rates at which banks lend to households and firms, and hence the amount of credit in the economy. And they influence long-term market interest rates too.

Take the yield on a five-year government bond. It is simply the weighted average of expected short-term interest rates over the next five years, plus a risk and a liquidity premium. A rise in short-term interest rates typically has two effects on long-term rates. It raises the five-year weighted average slightly. And it also affects expectations of future short-term interest rates.

If, for example, investors believe the Fed is raising rates preemptively to prevent inflation rising, then expected future interest rates may fall, and so would five-year yields. However, if the rate increase is seen as a belated recognition by the Fed that inflation is likely to rise, five-year rates may rise in anticipation of further rate increase to come.

The graphical relationship between interest rates on securities of different maturities is known as the yield curve. Yield curves typically slope upwards, because investors demand a risk premium on bonds of longer maturities to compensate for the extra uncertainty associated with lending for a longer periods. But when monetary policy is tightened and short-term interest rates are increased, it is possible sometimes for the yield curve to become inverted, sloping downwards for all but the shortest maturities.

Most central banks set monetary policy with the aim of keeping inflation low. The European Central Bank (ECB) has the statutory goal of “price stability”; the Fed also has a duty to support employment and economic growth. In most rich countries governments now define central banks’ aims, but allow them to pursue them without political interference.

To meet their aims, central banks usually adopt intermediate targets as well. These guide policy, as well as keeping expectations of inflation low. Ideally, the targets should be variables the central bank can control which have a predictable relationship with its ultimate goal, inflation. In practice, ideal targets do not exist, so a trade-off must be made between controllability and predictability.

One option is to target money supply growth. The narrowest money measure is the monetary base, or Mo, which consists of cash and bank reserves. M1 also includes checking accounts. Broader measures, such as M2 and M3, encompass interest-bearing deposits and some short-term securities. Central banks have greater control over narrower measures of money supply, but broader measures are more closely correlated with future price changes.

Money-supply targeting was popular in the late 1970^s and early 1980^s, because there seemed then to be a stable link between money-supply growth and future inflation. But it had two big drawbacks. First, it led to volatile interest rates, partly because banks’ demand for cash is sensitive to small interest-rate changes. And second, the historical relationship between money-supply growth and inflation broke down, partly because financial deregulation and innovation made the demand for money unpredictable. The ECB has adopted a monetary “reference value” forM3, but it has eschewed a binding target.

Moving Targets

A second option is an exchange rate target. A country with a poor record of controlling inflation can peg its currency to that of a low-inflation economy. In effect, this allows it to piggy-back on the low-inflation country’s credible monetary policies. Many developing countries fix their currencies against the dollar, and, under the European exchange-rate mechanism, European countries used to peg their currencies to the German mark. But with freely mobile international capital movements, exchange-rate pegs have become vulnerable to speculative attack. So now most rich countries either have permanently fixed exchange rates, as in the euro area, or they have floating rates and control inflation in other ways.

A third option is to target inflation directly, which is what a growing number of central banks now do. Australia, Britain, Canada, New Zealand and Sweden have explicit inflation targets. These have many advantages, notably transparency and the accountability. But they are not without problems. For one thing, because monetary policy operates with long lags, central banks have to adjust policy on the basis not of current inflation, but of future inflation, which is difficult to forecast.

Some economists also argue that inflation targets focus too narrowly on consumer-price inflation, which may lead central banks to ignore potentially harmful asset-price bubbles. In Japan in the late 1980^s, the Bank of Japan failed to check soaring share and property prices, because consumer-price inflation remained low. When the bubble burst, the economy plunged into recession.

As well as setting monetary policy and regulating the banking system, many central banks used at one time to finance governments’ budget deficits. When government spending exceeds tax revenues, the difference is financed by selling government bonds. If these are sold to the public, then the net effect on the money supply is zero. But if they are purchased by the central bank, the money-supply rise that accompanies the deficit is not offset: this is known as “printing money” or “monetising the deficit”. Nowadays, central banks in most rich countries are forbidden from financing the government’s budget deficit. But there is strong pressure on the Bank of Japan to buy government bonds to kick-start the Japanese economy.

Central banks’ monopoly on supplying cash and bank reserves is relatively new. In the 19^th century, private banks in Britain and America issued competing currencies. A return to such a “free-banking” era seems unlikely, but even if central banks’ monopoly is not in danger, it may eventually become irrelevant. Privately issued electronic money could one day complicate or even nullify central banks’ ability to set interest rates. Central banks are not about to vanish overnight. But they may not retain their pre-eminence forever.

VOCABULARY:

lender of last resort	кредитор последней инстанции: функция центробанка по поддержанию стабильности финансовой системы – центральный банк обязуется предоставлять кредит коммерческим банкам по официальной учётной ставке
fixed-income market	рынок облигаций с фиксированной процентной ставкой
reserve account	резервный счёт: счёт, который коммерческий банк держит в центральном банке для соблюдения резервных требований, а также для проведения расчетов с другими банками
federal funds rate	процентная ставка по «федеральным фондам»: ставка, по которой банки США кредитуют друг друга на один день за счёт свободных средств в федеральных резервных банках
open market operations	операции на открытом рынке: купля-продажа государственных ценных бумаг
weighted average	средневзвешенное значение: средняя цена финансовых инструментов с учётом количества каждого из них
yield curve	кривая доходности: графическое изображение изменения во времени доходности финансовых инструментов с фиксированной ставкой
risk premium	рисковая премия: разница в процентных ставках (доходе) между рискованными и лишенными рисками активами
target	целевой ориентир
trade-off	компромисс, уступка, оптимальное соотношение
reference value	стоимость-ориентир

 

 

Text E

Read the text and outline the key points.

Translate the part “Spot the trend” from English into Russian.

3. Make a précis and an annotation on the text.

 

THE LLOYDS MONEY MACHINE

Globalisation is sweeping the world of finance. Ignoring that trend hasturned an also-ran into the world’s biggest bank - Lloyds TSB. In Britain, Lloyds Bank is a familiar face on the high street. Elsewhere, it is all but un­known to the general public. But its empha­sis on serving retail customers with extraor­dinary efficiency -along with its firm refusal to follow the financial industry’s drive for international diversification—has turned it into a money machine.

Measured by assets, Lloyds tsb is only the fourth-largest banking company in Brit­ain and 33^rd in the world. Take market value as the yardstick, however, and a dif­ferent story emerges. With a stockmarket capitalisation of £42.1 billion ($68.7 billion), LloydsTSB has become the world’s most valuable bank. Its shares are changing hands at seven times book value, twice as much as its British competitors command. A £l,000 investment in Lloyds shares five years ago would now be worth nearly £4,000.

Not long ago, such giddy numbers seemed a pipedream. In the mid-1980s, Lloyds Bank almost went bust in the back­wash from Latin America’s debt crisis. The bank had to write off £2.6 billion of dud loans, and its claim to be “a thoroughbred among banks” (its logo is a black horse) met with sniggers. Other British banks that had been hurt in Latin America went cap-in-­hand to their shareholders, who patiently gave them new money. Lloyds was in far worse shape, and its shareholders were dis­inclined to buy a rights issue. Brian Pitman, who became chief executive in 1983, de­cided that the best way to advance was to retreat. He jettisoned loss-making foreign subsidiaries, wound down investment banking and international lending, and concentrated on the bank’s bread-and-but­ter business: selling financial services to British consumers.

This flew in the face of banking ortho­doxy, which confused size with strength. Mr Pitman, who became Sir Brian in 1994, insisted that increasing the share price was more important than expanding the balance sheet.

The bank’s”declared aim is to dou­ble the share price every three years. This is not just hot air: it has met this goal consistently for the past 15 years.

«He was the first to realise that planting flags around the world was not always the best way to make money», says Fred Crawley, a former Lloyds executive.

Spot the trend

The attention to shareholders has been accompanied by a knack for sensing the di­rection in which banking was moving. Lloyds was the first big British bank to buy a life assurer, Abbey Life; the first to offer mortgages and to bid for a building society, Cheltenham & Gloucester; the first to close much of its branch network; and the first to bid (unsuccessfully) for another clearing bank, Midland, sparking much-needed banking consolidation in Britain.

The £ 1.8 billion purchase of Cheltenham & Gloucester in 1994 gave Lloyds a valuable brand through which to push its own mortgage business, which had been flagging. Lloyds now issues 16% of new mortgage loans in Britain. In 1995 Sir Brian went after tsb, an institution whose strategy was so obscure that wags had dubbed it “That Sorry Bank”. But TSB could help plug gaps—it had lots of branches in Scotland, where Lloyds had few—and of­fered plenty of scope to cut costs by elimi­nating overlaps. Not all the savings have come from tsb. Lloyds discovered that some of tsb’s businesses were better than its own. The telephone bank, which has 800,000 customers, is run by managers from tsb.

These acquisitions have given Lloyds tsb a retail-banking breadth that no other British bank can match. It is the market leader in cheque-writing accounts and per­sonal loans, and the second-largest credit-card issuer. It pumps Lloyds, tsb and c&g products to 15m customers through a net­work of 2,700 branches, hundreds more than its nearest rival, NatWest.

Lloyds TSB, however, cannot trace its blessings to good management alone. Brit­ain has offered an ideal banking environ­ment in the mid-1990s: the economy has been buoyant, creating heavy demand for loans; long-term interest rates have dropped significantly, increasing the value of banks’ bond and loan portfolios; and rapid employment growth has reduced loan default rates. Under these conditions, the bank’s heavy exposure to Britain is a plus. But if the British economy sputters, ri­vals like to suggest, Lloyds TSB will sputter with it, far more than its more diversified competitors.

The stockmarket seems to think this an unlikely prospect. But it is clearly the big­gest risk in Sir Brian’s strategy. The bank has sought to reduce its vulnerability to eco­nomic swings by broadening its consumer-related business. A fifth of its profit now comes from insurance, primarily life insur­ance, which moves in a different cycle from consumer banking.

In trying to broaden its business, how­ever, Lloyds TSB runs head-on into a prob­lem that most other banks would envy: it simply earns too much money. It would gladly use this for acquisitions. But short of buying an­other big British bank and closing down hundreds of branches, which would almost certainly be blocked on competition grounds, it is difficult to imagine an acqui­sition that would be as profitable as Lloyds TSB’S current business. The bank is consid­ering a share buy-back as a way of returning that extra cash to shareholders.

The alternative lies in finding a second “home” market where Lloyds could work its magic. With a single currency looming, continental Europe has attractions. But few banks have a culture similar to Lloyds TSB’s - and few countries would allow the redundancies that would be necessary to meet stringent profit targets.

VOCABULARY:

retail customer	зд. мелкий вкладчик
to go bust	обанкротиться
to write off	списать
dud loans (bad loans)	безнадежные долги, невозвратные долги
rights issue	дополнительный выпуск акций
foreign subsidiaries	филиалы за границей
investment banking	инвестиционная деятельность банков
international lending	кредитовых иностранных клиентов
balance sheet	балансовый отчет
life assurer	фирма, занимающаяся страхованием жизни
clearing bank	клиринговый банк
mortgage loans	ипотечные кредиты
overlaps	зд. параллельные, дублирующиеся расходы
telephone bank	банк, осуществляющий обслуживание клиентов по телефону
cheque-writing accounts	чековые счета
personal loans	личные ссуды, т.е. ссуды частному лицу
loan default	несвоевременное погашение ссуды
buy-back	«обратная покупка» (акций)

 

Text F