By Emil Bjerg, journalist and editor of The World Financial Review
Historic bank collapses in the US, panic in the European bank sector. The recent turmoil has experts asking if we’re on the verge of a new severe financial crisis.
We certainly live in times of great volatility. Last Friday in the US, the second-largest bank crash in history occurred, causing fears of a new economic crisis. By the time of writing, the worse has passed in the American economy, and investors and large customers at American banks can let their shoulders drop an inch. The panic since spread to European banks following turbulence for the structurally important Credit Suisse. With the worse turbulence over – for now – we look back at a week to remember in the banking sector.
Behind the Silicon Valley Bank crash
Why did American tech’s favourite bank crash? As the name suggests, Silicon Valley Bank is a money lender primarily catering to the tech industry and start-ups. Until recently, the tech industry has been booming, raising lots of venture capital and benefitting from the economic climate during the corona crisis. As the business has flourished for the tech industry and start-ups, so has their go-to bank, SVB.
The recent shift to high inflation and hiking interest rates has brought around a shift in tech. With a more cautious investor climate, capital is running low in tech companies and start-ups.
As companies simultaneously have been taking out money to keep afloat, SVB had to sell out assets. While this is not an atypical situation for a bank, it represented a challenge due to the high interest rates. High interest rates are bad news for banks, especially for a bank with a substantial part of its assets in bonds – as SVB had. Bonds drop in value as interest rates go up. To raise capital, SVB deemed it necessary to sell a bond portfolio at a whopping $1.8 billion loss.
In trying to calm venture capital firms, Greg Becker, CEO of SVB, said that the bank had the “financial position to weather sustained market pressures.” By then, the panic was spreading on social media, with notable names, including Bill Ackman, saying that the bank might need a bailout.
When SVB did fail, it was due to a mix of the current economic climate, their large hold of bonds, and their niche specialization, catering to a challenged industry. Signature Bank, which crashed following SVB, is also a niche bank catering to the troubled cryptocurrency industry. Following SVB, Signature Bank’s crash is the third biggest in history.
The FED and Biden step in
Following the historical failures, fear of a general bank run spread. The relief came last Sunday when the Federal Reserve stepped in to stop a pushover effect on banks across the US. The FED agreed to backstop all depositors for both Silicon Valley Bank and Signature Bank, as well as offer loans to other banks in need of liquidity. All done in an attempt to convince consumers and companies that their money can safely be kept in American banks.
In a speech Monday morning, president Biden guaranteed depositors: “Americans can have confidence that the banking system is safe. Your deposits will be there when you need them“. In his speech, Biden stressed that the Federal Deposits Insurance Corporation would also cover amounts exceeding the standard $250,000 FDIC coverage limit.
While combined efforts worked to stop the chaos and contain the contagion in the US, turbulence in the European economy soon followed.
Credit Suisse and chaos among creditors
Wednesday, the 15th of March, turbulence spread in the European bank sector. The chaos happened after the Saudi National Bank said they could not buy more shares for regulatory reasons.
While Credit Suisse is the 17th biggest bank in Europe, it’s one of just 30 financial institutions globally designated to be systemically important by the Financial Stability Board. Following the statement from the Saudi National Bank, multiple European banks’ stocks were plummeting.
In an apparent attempt to restore investor confidence Alex Lehmann, Chairman of Credit Suisse Group, said that government assistance “isn’t a topic.” In saying so, Lehmann tried to distance Credit Suisse from SVB – which was bailed out by the American state. “We already took the medicine,” Lehmann remarked, referring to the bank’s strong balance sheets and capital ratio. It didn’t calm investors – the stock was down 24 percent at its low.
To alleviate worries of bankruptcy, later the same day, Credit Suisse did, in fact, accept help from the state when they took 50 billion Swiss Francs, or approximately 54 billion USD, from the Swiss central bank.
On Wednesday, the panic at Credit Suisse quickly spread to other European banks and the Euro. At its lowest, the SX7P Index was down by almost 7 percent. The Euro slid by 1.5 percent.
Thursday, with Credit Suisse secured by the Swiss central bank, both Credit Suisse, the SX7P Index, and the Euro look stabilised. However, the turbulence of the last week proves that stability is not to be taken for granted at the moment.
Different approaches to risk management
As we’ve entered highly volatile times, European banks look better geared to handle the uncertainty, relying on the sector regulation taking place after the 07/08 crisis. In the US, former president Trump removed critical parts of the Dodd-Frank Act that regulated the sector. That means that small and mid-sized banks with assets below 250 billion USD have been granted exemption from “stringent capital requirements imposed on larger institutions.” They’re also not obliged to undergo financial stress tests carried out by the Federal Reserve.
Banks in Europe take a more proactive approach to risk management, utilizing strategies such as capital requirements, loan-to-value ratios, and stress tests. This approach is intended to provide stability and prevent a potential financial crisis. In contrast to the proactive European approach, American banks have a more reactive approach, exemplified by the official action taken last week.
Moody’s, the bank rating giant, recently downgraded the American banking sector, while it hasn’t downgraded the European in the wake of the Suisse Credit panic. “A critical difference between the European and US systems, which will limit the impact across the Atlantic, is that European banks’ bond holdings are lower and their deposits more stable, having grown less rapidly,” Moody’s stated.
In Biden’s Monday speech, he complained about his predecessor’s interference with the Obama-Biden administrations Dodd-Frank Act. “I’m going to ask Congress and the banking regulators to strengthen the rules for banks to make it less likely that this kind of bank failure will happen again and to protect American jobs and small businesses,” Biden vowed.
Interest hikes and banks in trouble
The recent turbulence in the US and Europe raises a fundamental question. When banks are in trouble – to a large extent because of the increases in interest rates – can the European and the American central banks continue to raise interest rates to fight inflation?
Thursday afternoon, the European Central Bank raised interest rates for the sixth time in a row, once again by half a percentage point. Until now, the ECB has announced new hikes in advance, but for now, the central bank refrains from announcing future hikes: “The elevated level of uncertainty reinforces the importance of a data-dependent approach,” a statement from the central bank said. In a subsequent statement, Christine Lagarde said they would likely have “more ground to cover” when it comes to interest rates.
The Federal Reserve made its last increase in interest rates back in February but is expected to raise interest rates again next week.
“When is the next Fed meeting?” is a question that hasn’t weighed this heavily on anxious investors’ minds in probably four decades,” Dan Burrows from Kiplinger remarks. As both the ECB and the FED continue to look determined to reduce inflation, investors – and banks indeed – can continue to follow interest rates closely.
