Costly capital and the risk of rare disasters - speech by Ben Broadbent

In a speech delivered at Bloomberg in London, Ben Broadbent – External Member of the Monetary Policy Committee (MPC) – argues that investors’ fears about downside risks and the possibility of an extreme economic outcome has driven a rise in the premium for risky investment, however it’s financed. He suggests that those fears, in turn, have affected the growth of UK activity, investment and productivity.

Published on 28 May 2012

Ben Broadbent observes that the risk-free interest rate in the UK has fallen steeply since the onset of the financial crisis, and that quoted rates on new bank loans have declined. This, on its own, should spur new investment. But anecdotal and empirical evidence suggests financial markets and firms are behaving as if the cost of funding new projects has actually increased. That is partly because credit is being rationed by banks, who may only be willing to extend new loans to firms who keep debt within certain limits or hold minimum amounts of cash. Consistent with this, there is evidence that larger firms have been switching away from bank debt towards issuing debt and equities. This suggests that quoted interest rates significantly understate the true cost of bank debt.

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