A sense of dread has infiltrated the banking industry. It should be an alien emotion, given banks’ general rude good health. They are much better capitalized and regulated than they were 15 years ago, when the financial services firestorm turned hundreds of them into smoking ruins.
But still, the four bank collapses this month, starting with Silicon Valley Bank (SVB) and culminating – or maybe not – with Sunday’s rescue of once-mighty Credit Suisse CS-N, demonstrate that all is not well in the banking world. Confidence can evaporate overnight even with banks that, on paper at least, show no signs that they are candidates for imminent implosion. And once bank runs start, they are almost impossible to stop, all the more so with the advent of electronic banking. Press a button and your money flees.
Layer in the theory that soaring interest rates could trigger a recession and you might, just might, have a recipe for more bank failures. Bank crises happen every decade or so. Perhaps another one is on the way.
Credit Suisse’s forced rescue should not, in theory, have been needed, even if the outflow of clients and deposits accelerated after the March 10 implosion of SVB. Most of the financial ratios that measured the health of Switzerland’s second-biggest bank were not in red-line territory – far from it.
Credit Suisse was losing money, but its Tier 1 capital ratio (a measure of a bank’s ability to absorb losses) was well in line with European averages. Its liquidity coverage ratio (a bank’s ability to fund cash outflows) was strong despite the mounting withdrawals. In the fourth quarter alone, customers yanked 111 billion Swiss francs ($165-billion) from the bank, yet Credit Suisse still had ample high-quality assets it could sell.
The bank’s health had apparently benumbed its senior executives. They were promoting restructuring plans to refocus the business only days before the Swiss government and regulators essentially demanded that UBS Group UBS-N, Credit Suisse’s bigger crosstown rival, ride to the rescue. On Sunday, UBS agreed to buy all of Credit Suisse – it’s a complex business, more than just a bank – for US$3.25-billion, a deal sweetened by a torrent of loss-coverage guarantees, liquidity injections and debt writeoffs.
The Credit Suisse debacle showed that fear can turn customers into flash mobs demanding their money back. Even an emergency 50 billion Swiss franc lifeline handed to it last week by the Swiss National Bank failed to slow the outflows.
Who to blame? Certainly, the fear factor ramped up dramatically after the collapse of SVB and the subsequent failures of Signature Bank and Silvergate Bank, as well as the near failure of First Republic Bank, thrusting the apparently healthy Credit Suisse into crisis. A mere rumour spread on social media can provide the spark. It would be foolish to assume the bank failures will end with Credit Suisse, all the more so since the prevalence of deposit insurance has encouraged banks to take more risks and get sloppy with financial oversight, as apparently happened at SVB.
The end of the era of rock-bottom interest rates and easy money will also increase the odds that more banks will fail, even if a repeat of the devastation seen in the 2007-2008 financial crisis seems highly unlikely.
Spooked by rising inflation, central banks in the West, starting with the Bank of England in late 2001, have been ratcheting up interest rates steadily, even as Russia’s invasion of Ukraine 13 months ago, and the energy shock that followed, threatened to plunge oil and natural gas importers such as Germany, Britain and Italy into recession.
Interest-rate hikes hurt banks in at least two ways. The first is that they erode the value of their often enormous holdings in long-term, fixed-rate bonds such as U.S. Treasuries. SVB was loaded with underwater bonds, and the losses on that portfolio played an instrumental role in the bank’s sudden collapse.
The second is that rate hikes boost the odds of recession. The International Monetary Fund reported on March 15 that housing prices were falling in most OECD countries, with the biggest recent retreats in Denmark, New Zealand, Sweden and Canada. Mortgage rates are increasing, putting strain on households. By the end of 2022, the average 30-year fixed-rate mortgage in the United States rose to a two-decade high of 7.1 per cent.
Falling housing prices may be a sign that a recession is coming, as is rising unemployment. In February, unemployment in the United States edged up to 3.6 per cent from a 50-year low of 3.4 per cent in January – a bad omen.
Recessions hurt banks. Everything from initial public offerings to the sale of mortgages will slow, and loan defaults will rise if the downturn proves severe. Bank profits will fall. Already, European banks are not earning their cost of capital, which means shareholder value is being eroded.
The threat of recession and the nasty string of bank failures in March spooked investors. The rescue of Credit Suisse may signal that the worst is over. But as we learned this month, bank runs can come out of nowhere the moment confidence wanes. It is far too early to say it won’t happen again.