Financial woes: A woman is seen crossing a road as logos of the Swiss banks Credit Suisse and UBS are displayed on buildings in Zurich, Switzerland. The 167-year-old Credit Suisse is the biggest name ensnared in the turmoil unleashed by the collapse of US lenders SVB and Signature Bank. — AP
ALTHOUGH it’s been over 14 years since the 2008-2009 global financial crisis triggered by the fall of Lehman Brothers on Sept 15, 2008, there are still plenty of lessons to be learned from this devastating financial crisis-induced Great Recession.
Barely a few days after the Federal Reserve (Fed) chairman Jerome Powell signalled that the ultimate level of interest rate is likely to be higher than previously if evidence continues to point to a robust economy and persistently high inflation, the collapses of Silicon Valley Bank (SVB), Signature Bank and Silvergate Bank in the United States.
It is compounded with the massive lifeline liquidity support given to Credit Suisse that have caused turmoil in global financial markets, unleashing worries that the United States regional banks-centric crisis has intensified fears of a broader contagion global financial crisis.
What are the fault lines causing the fallout of regional banks? Some have blamed it on the Fed’s ultra-low and loosened monetary policy during the pandemic, which has shifted gear to aggressive monetary tightening post pandemic to fight inflation at all costs.
Some attributed it to poor assets-liabilities and sound risk management.
The failed bank has concentrated deposits (that is relying heavily on corporate deposits as opposed to retail) and investment concentration (that is holding a large proportion of assets in loans and securities; and hence were disproportionately exposed to long-term interest rates).
A majority of lenders have received an influx of massive customers’ deposits, largely from the technology sector and startups (concentration risk), and the banks have invested the surplus deposits into safe and high-quality long-dated government bonds, which have promised good returns when interest rates were low.
But, when the Fed started to hike interest rates aggressively by 425 basis points during the course of 2022, this caused bond prices to crash, leading to unrealised mark-to-market losses (which is yet to crystallise so long as banks hold the bonds to maturity).
In the case of SVB, the losses were realised as they were forced to sell off their investments at a loss to raise capital, resulting in a loss of confidence and ultimately a bank run.
A combination of lower risk appetite, high inflation, high interest rate (borrowing cost), weakening business confidence and lower demand have led customers to deposit less and withdraw their deposits for operating capital.
Pressure mounts
Banks globally are facing the same pressure of macroeconomic parameters. Central bankers around the globe have normalised their interest rates from historic lows, causing bond yields to increase substantially and eroding the value of banks’ underlying assets.
This does not imply that all banks automatically face the same risk of the failed regional banks in the United States.
Banks with sound risk management of assets and liabilities, strong capital adequacy and liquidity positions, should withstand the shocks.
Is this implosion of failed banks a harbinger of a global financial crisis, a deja vu of the 2008-2009 global financial crisis? Will it escalate into a wider contagion to effect not only within the United States but also spread to other major financial markets, triggering a systemic crisis?
Global regulators and central bankers are keeping a close eye on the current development as they gauge the direct and indirect exposure of their domestic banks to these failed banks and prepare to undertake forceful measures and liquidity operations to stem contagion risk if the banks fallout develops into a wider proportion of financial and economic impact.
We reckon that there could be a ripple effect in the US banking system and economy. It should be “manageable”, albeit it has dented confidence.
Having learned from the painful lessons of the 2008-2009 global financial crisis, swift and unprecedented measures as well as financial resources are expected to be put into place by the governments and banking regulators to contain the fallout and also stem a repeat of systemic financial crisis.
The US regulators have taken extraordinary measures to ring-fence the failed banks through a back-stop guaranteeing of the bank’s depositors’ money to shore up confidence in the financial system.
In the case of Credit Suisse, it is “too big” to fail as the fallout of Switzerland’s second-largest bank, the magnitude of financial ripple effects, will be more severe, like a Lehman Brothers moment.
Time is of the essence. The regulators’ decisive and forceful emergency measures to backstop all the depositors of the failed bank can eliminate a self-fulfilling panic if depositors and creditors believe that the lender of last resort (the Fed in this case) is prepared to address any liquidity pressures that may arise. Protecting the interests of depositors remain the top priority.
Governments and central bankers must avoid systemic financial or banking crises as they can be very damaging and can possibly have lasting impact on the economy. Collapsing trust in the banking system and depositors’ run, lenders’ collapsed as well as borrowers’ default have significant negative consequences for economic and business activities. Self-fulfilling credit market freeze and curtailed lending to households and businesses would grind the economy to a standstill.Economic slowdown
The effect of share wealth loss due to a sharp falling stock market, followed by demand retrenchment could push the already slowing global and US economy into a deep economic slowdown or in the worst case, tailspin into a deep recession.
Financial spillovers is still a risk for the US economy, complicated by the Fed’s continued monetary tightening path, albeit a smaller magnitude of interest rate hikes in 2023 would amplify recession fears.
The Fed is juggling its delicate balancing act between keeping price stability (controlling inflation) and ensuring financial stability in stemming the contagion risk from current banks’ fallout rout.
While the incidence of systemic banking crises and financial crises that have had happened over the past twenty years with high financial, economic and social costs, we forget the painful lessons and repeat the same mistakes despite increased regulations and oversight of the banking sector.
Some of common elements appear in most crisis-specific countries are:
> Economic and financial shocks inflicted by excessive imbalances such as consumer credit lending to unproductive sectors.
> Over-leveraging of the corporate and household sectors, resulting in payment default due to rising interest rate (credit risk).
> Liquidity risk (withdrawals exceed the available funds).
> Interest rate risk (rising interest rates reduce the value of bonds held by the bank, and force the bank to pay relatively more on its deposits than it receives on its loans)
> Unchecked hazardous banking practices.> Ineffective regulations and supervision.
> Ineffective assets and liabilities risk management.
> Unsound corporate governance mechanisms in lending and investing.
These interrelated and multidimensional causal factors are complex and hence, reinforce the need for sound prudential regulations and supervision, not only in bad times but also during the good times.
That’s why strong financial regulation is important in ensuring the safety and soundness of the financial system and protecting the bank’s consumers and depositors.
Rules and regulations, as well as enforcements, are in place to stop things from going wrong, and to safeguard the stability of wider financial system.
Beyond strengthening capital adequacy and liquidity position to buffer against the shocks, banks are required to undertake periodic and vigorous stress testing, holding a minimum amount of cash or liquid assets to protect against unanticipated shocks or withdrawals such as sudden bank runs on deposits.
In some cases it is to meet hedging requirements against the risks from losses on bonds and other assets and also have better matching of assets and liabilities.
Banks are also required to put in place a credible and sound risk management framework to detect and mitigate any new risk activities or predict forthcoming disruptions, which can be triggered from technological advances, macroeconomic shocks or banking scandals.
In a fast-paced digitalised technology age, the risk management must cover cybersecurity controls, anti-money laundering and financial crime risks and exposure and stress testing in relation to climate change and biodiversity risks.
Collectively, robust prudential standards and regulations, sound risk management framework as well as responsible lending ensure the resilience and sustainability of the financial sector, and strengthen the resilience of banks in navigating through the periods of extreme stress.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
