Is there a banking crisis, or just a market reshuffle?
Is the banking system in crisis? Not really, say two UNSW Business School experts – but there is cause for concern
Earlier last month, the Santa Clara, California-based Silicon Valley Bank collapsed. A fellow US regional bank, Signature Bank, also collapsed, and another institution, First Republic Bank, was also seen to face significant issues.
Since then, US President Joe Biden has reassured the American people to have confidence in the banking system. Similarly, the US Federal Reserve chair, Jerome Powell, has assured the US Congress that US banks are sound. First Citizens Banks acquired the deposits and loans of SVB, the US Treasury facilitated the sale of the UK branch to HSBC, and SVB depositors were protected from the fallout by the Federal Deposit Insurance Corporation (FDIC).
All of these actions were undertaken, in part, to shore up confidence that the damage would be limited. But after the financial trauma of both the 2008 Global Financial Crisis (GFC) and the pandemic, online netizens were not so sure. Trending articles and social forums have been buzzing with chatter that these are signs that the global financial system was either not working or near collapse. It's a climate of jangled nerves in regard to the global banking system - and one that wasn’t helped when Credit Suisse, the second-largest bank in Switzerland, also collapsed. (It was later bought by UBS.)
So, are these fears from the public a bit overamped? Or are they closer to the truth than we may be comfortable with? Associate Professor Zhaoxia Xu and Dr Thuy To from the School of Banking and Finance, UNSW Business School, explain.
What is happening in the world of banking?
Dr Thuy To: The collapses of several banks, including both commercial and investment banks, at different jurisdictions, have made the markets ask the question: “Is there a systematic problem in the banking industry?”. Governments and regulators around the world are quick in their actions to contain concerns of contagions. However, underlying issues are for the industry to learn and address.
Associate Professor Zhaoxia Xu: The global banking sector is facing high risk due to the failures of Silicon Valley Bank (SVB) in California and Signature Bank in the US and the financial trouble of Credit Suisse in Switzerland.
To shore up confidence and avoid a bank run, central banks like the US Federal Reserve in America have taken actions to make extra cash available to make sure financial transactions continue as normal, despite concern over the SVB collapse. Credit Suisse was taken over by the Swiss bank UBS. These actions have helped stabilise the global financial system and financial markets.
We’re seeing terms like ‘financial crisis’, ‘banking turmoil’ and ‘meltdown’ mentioned by the media in regard to the global banking system. Is this warranted?
Dr To: We have seen bank failures, but for various reasons. There are causes for serious concerns. However, the regulators, policymakers and banks are learning from it. Therefore, it is likely that the banking sector will improve over time.
Associate Professor Xu: The current global banking system is not yet at the stage of ‘crisis’ and ‘meltdown’, but the banking sector is still at high risk.
According to the recent study by Jiang, Matvos, Piskorski, and Seru (2023), nearly 190 US banks may endanger their insured depositors, with potentially $300 billion insured bank deposits at risk, if only half of the uninsured depositors decide to withdraw their funds. It is important for regulators to monitor risks and remain vigilant in overseeing the banking sector, being wary of bank collapses, and maintaining financial stability in the financial sector.
To what extent was risk management a contributor to the current situation?
Dr To: Risk management, or the lack of it, is playing a large role in the recent demise of some banks. In the case of Silicon Valley Bank, it’s the interest rate risk and liquidity risk management. In the case of Credit Suisse, operational risk is more of an issue, where both oversight and compliance have failed.
Associate Professor Xu: The collapse of SVB and Signature Bank is in part because they failed to properly manage interest rate and liquidity risks. When banks borrow short-term and lend long-term, they are exposed to interest rate risk. Rising interest rates can result in increased short-term funding costs without a corresponding increase in asset returns, leading to squeezed profits and potential losses that could cause a bank to fail.
Banks face liquidity risk when they are not able to meet their obligations to depositors and other creditors due to a lack of sufficient liquidity or cash on hand. When a bank is unable to fulfill its obligations due to liquidity risk, it may be forced to sell assets quickly, often at a loss, to obtain the required cash. This action could worsen the bank's financial position and lead to a downward spiral of financial difficulties.
Liquidity risk is especially important when banks have large amounts of uninsured deposits. Both SVB and Signature Bank had a significant portion of their assets in long-term bonds with relatively low yields before the Fed's interest rate hikes, while about 90 per cent of liabilities were in the form of uninsured deposits. When markets became aware of the large number of uninsured deposits in SVB and Signature Bank and realised that they did not have sufficient ability to liquidate assets to meet potential withdrawal demands, a run was triggered. Both banks failed to diversify their liabilities and properly manage their risk exposure.
Will Australia be impacted?
Dr To: The Australian banking sector has a very sound risk management supervisory and practice in place. The overall public confidence in our banking system is also good, so the risk of a bank run is lower.
Associate Professor Xu: The direct impacts on Australia are relatively limited. The failed US banks, such as SVB and Signature Banks, do not have any branches or subsidiaries in Australia. But Credit Suisse has a presence in Australia through its subsidiary, Credit Suisse AG, Sydney Branch which offers a range of financial services, including investment banking, wealth management, and asset management. Some Australian banks may have exposure to those banks through syndicated loans or other financial instruments.
There is minimal risk of any Australian banks collapsing, however, we are not immune to the global systemic risk because of the interconnectedness of the banking sector.
There is a chatter online that we ‘frequently’ see boom and bust cycles. Are banking crises common?
Dr To: Cycles are unavoidable in the world of business. However, banks play a critical role in the economy, and their health affects the lives of ordinary citizens, therefore cycles become undesirable, magnifying the perceptions of their existence. Regulators around the world are working together to provide prudential governance, aiming for a stable financial system.
Associate Professor Xu: Banking crises characterised by significant signs of financial distress in the banking system do occur from time to time globally. Although most countries have experienced at least one systemic banking crisis, only three countries (Argentina, the Democratic Republic of Congo, and Ukraine) experienced more than two systemic banking crises during 1970-2017, according to the study by Laeven and Valencia (2020).
Does this latest crisis foreshadow changes in banking systems, government policies and regulations?
Dr To: We do expect closer scrutiny and supervisory of the bank operation and risk management system. The banks themselves realise the importance of sound internal risk management, oversight, and compliance.
Associate Professor Xu: The regulatory framework's weaknesses were exposed by the SVB's failure. Since the minimum threshold for the Dodd-Frank Act stress testing was raised from $50 billion in assets to $250 billion in assets in 2018, small and medium-sized banks have been subject to weaker requirements and supervision.
Moreover, stress tests typically do not assess risks related to abrupt changes in interest rates. It is likely that regulators, including Australia, will strengthen oversight and regulation to reduce the risk of future banking crises.
How might all this impact the credit crunch?
Dr To: With heightened compliance requirements, the costs for the bank operation do increase. However, this can fuel innovations to reduce costs and improve competitive margins, for example, the use of big data, automatic platforms, integrated services etc. Credit will be available, though there can be different allocations.
Associate Professor Xu: The consequence of the SVB crisis on credit conditions is expected to be significant. The uncertain environment for banks and their efforts to strengthen balance sheets to prevent deposit outflows and assure regulators will lead to further tightening of the credit markets.