Secondary banking crisis of 1973–1975

The Secondary Banking Crisis of 1973–75 was a dramatic crash in property prices in Great Britain which caused dozens of small ("secondary") lending banks to be threatened with bankruptcy.

During the 1973–1974 stock market crash in the US, the unemployment skyrocketed to 9% by mid-1975—the highest rate since the Great Depression. The stock market as measured by the Dow Jones index decreased 25% between 1969 and 1971 and then lost another 20% by mid-1975. The oil crisis, recession and financial instability combined to create the sharpest fall in global share prices since the Great Depression and World War Two. The period saw also the failure of major international banks such as Franklin National in the US and Herstatt in Germany.

The crisis
The secondary banks emerged during the 1960s, and their main business was lending funds obtained in the wholesale money markets - also a relatively recent development at the time - to sectors such as commercial property. These had been shunned by the major clearing banks both for reasons of risks and because the clearers were subject to either the operation or the threat of credit controls. As a result, they tended to reserve credit for established business customers. The establishment of secondary banks was at the time a relatively easy process, with little examination of the institution or its managers, and little formal supervision.

The abolition of credit controls on all UK banks in the reform of 1971 - "Competition and Credit Control" (CCC) - sharply increased competition in the banking sector, which together with a relaxation of macroeconomic policy contributed to a rapid increase in lending, a stock-market and property boom. The main clearing banks took advantage of the liberalization to lend to the sectors previously dominated by the secondary banks. Meanwhile, the secondary banks' own balance sheets expanded rapidly, balancing money-market liabilities with long-term loans, largely to property and construction companies.

The interbank market grew rapidly in the early 1970s - foreign currency interbank credits to European BIS reporting banks rose from $9bn in 1970 to $21.8bn in 1974. After the generalized floating of exchange rates in the early 1970s, many commercial banks expanded their foreign-exchange positions. For example, currency instability increased demand for forward cover for non-bank firms. At some banks, internal controls were clearly inadequate, leading to concentration of risk.

The 1973 oil-price increase heightened volatility of markets and disrupted patterns of capital flows. Several banks were caught by unexpected depreciation in some currencies together with a tightening of US monetary policy.

The authorities acted in 1973 to reduce demand and the rising inflation that had accompanied it, by raising interest rates and tightening fiscal policy. These led to sharp falls in share and property values, aggravated by the advent of the oil crisis. These in turn weakened the balance sheets of secondary banks - whose assets were often secured on such collateral. Deposits began to be withdrawn. To address what was assumed to be a liquidity crisis, the Bank of England tried to avoid direct money creation or interest-rate reduction. Instead, the clearing banks were persuaded to pool funds for a 'lifeboat' operation to save the financial system from the consequences of widespread failures of the secondary banks, with the Bank providing 10 percent. Eventually, twenty six banks were supported by up to £1.3bn in loans. In addition, additional funds were sought from shareholders of secondary banks; shareholders were persuaded to dilution of their holdings; creditors were pressured to forego rights to foreclosure; in some cases, 'relationship' banks supported their secondary-bank customers; and direct assistance was provided by the Bank in the form of credit agreements.

In the course of the rescue, it became apparent that many banks faced insolvency and not illiquidity. The secondary banks who were assisted were obliged to reduce their operations; several were acquired by other institutions, including the Bank itself. Both the Bank of England and the clearers made losses (totalling around £150mn), although some were later recouped. The crisis was a major stimulus for the 1979 reform of supervision.