Is there a new financial crisis on the horizon?
Recent trends suggest that the global economy might be heading toward another financial crisis. While it’s always difficult to predict economic outcomes, it is important to capture all the signals and be prepared in case the trend points in that direction.
One way that we can do this is by using technology to empower private debt market actors. By giving them access to data and analytical tools, we can help them make better decisions and avoid some of the damage that a financial crisis can cause.
The current economic situation – Are we heading toward a crisis?
The economy seems solid on the surface, with global growth expected at 2.7% in 2023 (following 3.2% in 2022).
However, there are some troubling signs that suggest we could be heading for another financial crisis.
“The second quarter of 2022 saw global real GDP modestly contract (growth of –0.1 percentage point at a quarterly annualized rate), with negative growth in China, Russia, and the US, as well as sharp slowdowns in eastern European countries” as per IMF World Economic Outlook.
Inflation is skyrocketing:
- +10.7% in the Euro area in October
- +7.7% in October in US (after +8.2% in September which represented a 40-year peak)
- +11.1 in UK in October (surpassing 10.1% of September)
These numbers still do not tell the whole story as they only refer to the core inflation, which does not include food and energy prices. If we examine food and energy, the situation becomes significantly different.
Prices are now at levels we haven’t seen in decades, especially for some very sensitive and essential items such as energy and food. Central Banks are hiking interest rates in an effort to control inflation, but how long will consumers be able to take the heat and absorb higher costs?
Take the example of the UK, where from September 2021 to September 2022, domestic gas prices increased 96% and domestic electricity prices by 54%. It is easy to understand that households are under immense budgetary pressures.
Is affordability the new “house prices” (that will kick a new financial crisis)?
The trends summarized above will inevitably lead to some changes in consumer behavior, like the reduction of spending on non-essential items.
Affordability has hence become a hot topic right now. Businesses are trying to find ways to make their products and services more affordable for consumers, and many are using affordability as a key differentiator in their value proposition.
The big question therefore is: will consumers be able to adapt to these new prices (and keep up with their spending habits)? Or will they not be capable to absorb them? Will this also reflect on their ability to meet their payment obligations triggering default (causing a new financial crisis)?
A lesson from the past
Michael Burry did something that no one else in America was doing: reading and analyzing the pools’ mortgage loans bundled in mortgage-backed securitizations.
Thanks to his analysis he got a role in the movie The Big Short. But most importantly, he will always be remembered as the man who predicted (and maybe somehow triggered) the Great Financial Crisis. He was the only one running a proper credit rating analysis of the loans pool included in those transactions, and the only one to monitor them over time, appreciating the deterioration from quarter to quarter. Per his own words, “not even rating agencies that were issuing ratings for those securities, had ever looked through all those pools. “
Fast forward to today, and you don’t need anymore to be an “awkward and anti-social“ guy that spends hours staring at a computer screen to understand how a portfolio of thousands of single loans is made. You just need the the right technology.
The importance of technology in limiting and preventing crises
The financial crisis of 2008 was a wake-up call for the world’s financial institutions. Many parties recognized the need for the financial industry to have the right tools to prevent another systemic crisis.
But since 2008, financial markets have evolved massively (blockchain and digital lending platforms are just two examples) and data in general exploded (a 50x increase in data from 2008 to 2022). No organization, starting from regulators, can keep pace with the ever-growing data landscape.
Basic tools and more regulations are not going to help the market in the case of another financial crisis.
Financial actors need a way to easily access data and have proper analytical tools to observe the market. If systemic problems arise, they should be able to monitor them in time to develop proper damage control plans.
Someone has pushed even further, suggesting that “technology can act as a buffer and reduce the need for more regulation. […] lines of code and data can help prevent more lines in the federal register.”
A study conducted by the European Systemic Risk Board on US commercial banks, shows that the financial institutions that were leaders in IT adoption before the GFC proved to be significantly more resilient during the crisis. These results are testified by both lower delinquency rates (also in the case assets were sold to securitizations) and a lower NPL ratio in the toughest years.
A lower NPL ratio was not the only achievement, as low-IT adoption banks tightened lending significantly more during the GFC, therefore jeopardizing the recovery of profitability in the aftermath of the crisis.
It seems that, without a Micheal Burry in their team, investors better have the right technology!
Overview of the industry
95% of asset managers in North America believe that their technology, data, and digital capabilities will be competitive differentiators by 2025 (Accenture, 2021). The current situation is very different though: many asset managers remain in the early stages of adopting disruptive technologies (including artificial intelligence (AI) and cloud), with only 8% having completed their cloud journeys.
If asset managers are lagging behind in terms of technology adoption, banks are not in a much better position. In a pool of over 2,000 banks interviewed by IBM,, 8 out of 10 are still at the beginning of their tech transformation with still a long journey ahead.
Interestingly enough, the study also confirmed that institutions that are most advanced in the process of technology adoption achieve higher Return on Equity (ROE) and/or lower Cost Income Ratio (CIR).
Private debt market actors need to act now to stay ahead of competition
Technology is essential and the Covid-19 pandemic has accelerated its adoption.
Looking at credit dynamics in Italy before and after the pandemic outbreak, it is clear how credit drawn by high-tech banks increased by 11% after 2020, twice the rate recorded by other lenders.
Still, most of the industry is lagging behind.
A lot of things still need to be done to fully exploit the potential of technology and, as the economic situation gets worse, time is running out. Those institutions that want to be responsive to deterioration in markets will have to be able to catch the early signals to avoid having to deal with the consequences.
Technology solutions like the ones we offer at Cardo AI can help your business stay ahead of curve. Discover today how our innovative AI-powered platform can help you make better decisions and keep your institution competitive in these challenging times.