Global bank hysteria and the case of Silicon Valley Bank and Credit Suisse

Bank failures: just the beginning?

On 10-March-2023, the US witnessed its largest bank run since the failure of Washington Mutual in 2008 during the Great Recession. In a single day, Silicon Valley Bank (SVB) experienced a bank run with withdrawals of $41 billion dollars. Silicon Valley Bank earned its spotlight being a top 20 bank in the US, and as a high profile bank that funded almost half of startup tech companies in the US. However, prior to the SVB bank run, cryptocurrency-focused Silvergate Bank on 8 March was wound down due to loan losses. Subsequently on 12 March, Signature Bank, another cryptocurrency-focused bank, was closed by regulators due to the systemic risk it posed. The failure of these banks and its potential repercussions to the US financial system should not be underestimated, since these are relatively large banks and the collective size of their assets are larger than Washington Mutual when it failed (which was then about $310 billion).

Another reason why the bank failure should not be brushed aside is that the withdrawal of the $42 billion at SVB within a day was more astute than the withdrawal of the $16.8 billion at Washington Mutual across nine days. The bank run gained velocity in earnest when social media messages from its venture capitalists and founding investors raised concerns over the safety of deposits in SVB.

The behavioural component

Banks are essentially highly leveraged entities, whereby for every dollar received as deposit, several times of that is utilised in the form of loans or other risk-taking activities. This model has worked for years, and conversely, bank runs are not a new phenomenon. Therefore, while banks are often lauded to have stronger capital ratios and other bank financial ratios following the Great Recession of 2008 and the Basel Committee’s framework, the strength of banks are also underpinned by a more nebulous concept, confidence. In finance, returns are dependent on the amount of calculable risk that is undertaken, as well as incalculable uncertainty, and in this case, the confidence in banks. Consequently, when confidence declines, the risk premium on banks increase, and when that risk premium is incalculable, it can rise manifold simply because it is understood only in terms of uncertainty and fear. This fear then materialises as a bank run. Although a central bank’s deposit insurance will help contain the fear, there is a limit on the amount of deposits insured and therefore, a limit to how much it can stem general risk aversion in the financial markets.

Fear equates to generalised risk aversion in banks

Confidence in banks is crucial, without which, their survival is at stake. Another bank that has been adversely affected by confidence issues is Credit Suisse, the Swiss global banking giant. On 15 March, the Chairman of Saudi National Bank, a shareholder of Credit Suisse, said it was “absolutely not” open to further cash injections to support the already ailing bank. This has affected the valuations of Credit Suisse financial instruments severely, be it bonds, equities or derivatives, which led to the Swiss National Bank lending them a CHF50 billion to shore up its capital and confidence. Apart from the mark-to-market impact of the Credit Suisse debacle, the systemic nature of global banks and the failure in the three US regional banks would imply an increase in risk aversion towards the global banking sector, particularly those within the cryptocurrency and European banking space. Banks will come under increasing scrutiny which hopefully does not develop into mass hysteria.

Don’t blame central banks

The rise in global interest rates has often been blamed for the woes of the failed US banks and Credit Suisse, being victims of the increased cost of capital at a time when the supply of liquidity has contracted. However, the sudden shifts in liquidity should not have gone undetected due to the sharp fall in the cryptocurrency market in 2022, alongside the massive decline in equity prices of tech companies which happen to need fresh capital, particularly pertinent for the three cryptocurrency-focused US banks that failed. Meanwhile, Credit Suisse was already ailing in 2022 where it lost billions from the collapse of family office Archegos, and faces hundreds of millions of fines on money laundering scandals. Of course, years of easy monetary policy would have partly contributed to asset bubbles in financial markets, especially in areas of financial innovation such as cryptocurrency, and this is precisely why central banks have a strong intent to normalise interest rates.

Systemic impact?

The transmission impact to Asia appears to be limited despite pockets of uncertainties at this point in time. China’s regulator has stated that the SVB-Shanghai Pudong Bank partnership remains largely separate from US operations and would be unaffected. However, we note there may be tech firms in Asia that rely on US financial markets for sources of funding, although there have been no companies in Asia that have come forward to state their exposures to this unfortunate development. In Europe, the ongoing risk is whether the fear-induced shift in deposits from US-based cryptocurrency-focused banks would create a higher proportion of risky liabilities on the balance sheets of European banks. In addition, the liquidity issues at Credit Suisse will raise greater scrutiny on European banks, which could potentially shift funds to flow to conservative investment grade banks in Asia. In Asia, banks typically utilise their deposits for loans with very little being invested in financial trading or complex financial products. Nonetheless, fear in the financial markets is creating downdrafts in the global equities market alongside other risky assets such as commodities and emerging market currencies. Relatively, low risk assets such as investment grade bonds and government bonds are expected perform better than the risky assets space. Broadly speaking, the events of the failure of the US banks and malaise at Credit Suisse will reinforce the thesis for a slowdown in global growth and a rise in risk aversion that will benefit lower risk assets such as bonds.