Combating a new banking crisis

Mahmoud Mohieldin
Thursday 23 Mar 2023

News of problems at three major banks in the US and Europe has brought back worried memories of the 2008 global financial crisis.


True to the rule that “when it rains it pours,” another banking crisis has come on top of the multiple global crises that have struck since the beginning of the decade, from the Covid-19 pandemic to the natural ravages due to climate change and the deteriorating state of international relations that has brought a major war in Europe.

These things have sent inflation rates through the roof, raised the spectre of economic stagnation, and further crippled the developing nations’ ability to manage their foreign debt. While a banking crisis is the kind of financial disaster that has recurred for decades, recent developments in the banking sector have now triggered powerful memories of the last disaster when the 2008 world financial crisis led to frenzy in the financial markets and panic among the depositors and shareholders in many banks.

In an eerie replay of the fall of the US investment bank Lehman Brothers that triggered the 2008 financial crisis, the public has now been taken by surprise by the debacle of the Silicon Valley Bank (SVB) in the US.

Many people had never even heard of SVB before it teetered on the brink of bankruptcy. Only then did they learn that it was the 16th largest US bank, that it was 40 years old, and that it specialised in financing emerging high-tech firms. Over the last three years, its assets have surged from $70 billion in 2019 to nearly $210 billion. Wholesale institutions and funds dominated its $170 billion in deposits.

Earlier in March, SVB announced that it had sustained a loss of $1.8 billion in 2022 and that it was unable to raise the $2.25 billion needed through share offerings to plug the gap. The news triggered a run on the bank in which depositors withdrew more than $40 billion in just one day.

This was followed by Signature Bank in New York declaring bankruptcy. It had total assets of around $118 billion, but had recently experienced asset-management problems, including an increase in the ratio of unsecured deposits and in the ratio of cryptocurrency businesses among its depositors, to the extent that cryptocurrencies came to 30 per cent of its total deposits.

Suddenly, the two-decade-old bank was hit by a run of depositors who withdrew $10 billion from it in a single day.

As the saying goes, “crises come in threes.” From Europe then came the news that the venerable Credit Suisse Bank was also in trouble. The long-established Swiss bank has been ranked as a “global systemically important bank” by the Financial Stability Board, which means that because of its size and the ways it interconnects internationally its fall could severely rock the global financial system.

The bank has recently experienced a spate of managerial problems and financial losses that have led major investors to refuse to boost its capital in order to help ward off further losses. As a result, the bank’s credit rating and market valuation have fallen, while its shares have experienced high volatility, and the costs of financing its activities by issuing bonds have risen sharply.

These developments bring to mind what veteran professors of banking and finance sometimes say with respect to the fate of one bank, namely that “it worked successfully until it went bankrupt.”

The secret of this paradox lies in how the banks concerned have managed to turn profits into losses, which is to say how they exposed themselves to liquidity vulnerability that courted financial trouble and an inability to meet their obligations and therefore in some cases eventual insolvency. The response on the part of authorities differed depending on the case, although in all three cases, measures were taken to fully protect depositors.

The following points are important in understanding the crisis and the decisions taken by the authorities.

First, there are the repercussions from the delay in monetary restrictions followed by the accelerated rise in interest rates. The rapid succession of interest-rates hikes that followed a period of financial easing to cope with the Covid-19 pandemic threw the financial markets into havoc, and the volatility and rush of money from one portfolio to another became too fast and too large for the liquidity and risk-coverage capacities of some financial institutions.

Banks with portfolios heavy in long-term bonds suffered severe losses as a result of the declining value of the bonds in the wake of the interest rate hikes, especially as depositors shifted their money to other higher-yielding instruments.  

Second, there is the contagion of market panic. In a more stable environment, the financial regulatory authorities would not have been so worried as to come to the rescue of all depositors, as was the case with SVB and Signature Bank. They would have left it up to the normal mechanisms to deal with the rights of depositors insured up to $250,000, after which shareholders would divvy up whatever was left after the liquidation of the bank and meeting other outstanding obligations.

However, three factors triggered the regulatory authorities to intervene fast in these cases. The first was the lessons of the Lehman Brothers collapse in 2008 with its confidence-destroying effects that ricocheted throughout the global financial markets. The second was the critical situation of the economy, with spiralling inflation and anxieties over declining growth and the possibility of a descent into stagflation, all of which had to be kept under control, especially as the US heads towards a presidential election year.

The third factor was the need to act quickly to prevent the spread of panic and runs on the banks, especially given how fast news and emotions can spread in this day and age.

Third, there are questions surrounding the magic number 250. The aftermath of the global financial crisis saw the introduction of laws and regulations that set $250 billion and above in assets as a definition of banks that are “systemically important” and could jeopardise the financial sector if they failed.

These banks are subject to additional periodic audits to ensure the soundness of their operations and their liquidity levels and resilience to shocks. In 2018, it is claimed that SVB together with other parties campaigned to amend the laws so as to explicitly exempt banks with less than $250 billion in assets from these regulatory requirements on the grounds that they would not present systemic risks if they went under.

Even so, after their collapse, SVB and Signature Bank were still ranked as systemic banks, thereby justifying rescuing all their depositors. At the lower end of the 250 continuum is the regulation requiring that all deposits are insured up to $250,000. After the crisis struck, the financial authorities felt forced to cover all deposits including those well above the limit.

Fourth, there was an unprecedented intervention by the monetary and financial authorities. When faced with severe economic and financial difficulties, rapid and effective intervention is of the essence to forestall a crisis. On this occasion, the authorities took decisive action to calm the markets, revive confidence among depositors, and prevent a repetition of the 2008 crisis or worse.

They thus announced that all deposits at SVB and Signature would be insured and that the cost would be borne by the US Federal Deposit Insurance Corporation. They also launched a mechanism at the Federal Reserve that would work with the Department of Treasury to make urgent liquidity available in the event of a sharp rise in demands for withdrawals so that the banks would not suddenly have to sell off their financial assets.

The Swiss regulators also intervened quickly to facilitate the $3.23 billion acquisition of Credit Suisse by UBS by having the Swiss central bank make $100 billion available to the acquiring bank to help cover Credit Suisse’s obligations, according to the UK Financial Times. At the global level, the US Federal Reserve agreed with the European Central Bank and the central banks of the UK, Japan, Canada and Switzerland to set up a daily facility to inject dollar liquidity into the financial markets in the event of need. The mechanism went into operation immediately and will last until the end of April.

These rapid interventions show that some lessons have been learned from the 2008 global financial crisis. Indeed, the international financial system as a whole is more robust and solvent than it was before the crisis, but its resilience to shocks is still being put to the test. We can expect more analyses of what happened to the above-mentioned banks and whether their problems were the result of deficiencies in the regulatory systems or lapses in the application of the rules in the weeks and months to come.

There will be discussions on the criteria  that defines a systemically important bank and on the depositors’ insurance systems. Meanwhile, the Federal Reserve will probably go ahead with the expected quarter point increase in interest rates in the US, thereby reaffirming its resolve to control inflation and signalling that the financial situation is stable and does not necessitate a change in monetary policy direction.

I think that all this will have a pressure on the economy as demand declines due to the dual effect of restrictions on credit by the higher interest rates and the banks’ more judicious and more closely supervised management of their lending portfolios and investments. As for how this will impact the developing countries, much is contingent on the resilience of their economies and the flexibility of their policies in response to recurrent shocks.

* This article also appears in Arabic in Wednesday’s edition of Asharq Al-Awsat.

* A version of this article appears in print in the 23 March, 2023 edition of Al-Ahram Weekly

Short link: