Corporate Governance,Economics & Finance

Finding path forward after banking crisis

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banking crisis

The fall of Silicon Valley Bank and its ripple effects have left businesses wary. In light of the aftermath and market shifts, a banking expert at CUHK Business School offers guidance for navigating the unpredictable times ahead

All it took was two days for Silicon Valley Bank to collapse after its customers withdrew US$42 billion in a single day. This bank run triggered a chain of reactions that dragged Signature Bank and First Republic Bank to meet the same fate. All this happened over five days in March 2023, thanks to social media.

“It was the first Twitter bank run and the fastest bank run in history,” says Thomas Bain, Adjunct Professor of the Chinese University of Hong Kong (CUHK) Business School. “We got the information instantly in about 20 seconds and then everybody started pulling their money out.”

Professor Thomas Bain shares his insights during a luncheon talk.

As a comparison, the Wall Street crash in 1929 created banking panics a year later, and it took a few weeks for the fear of bank collapse to spread out across the states, prompting depositors to withdraw their funds in a frenzy, and ultimately contributing to the onset of the Great Depression.

In both crises, the banks were the ones to blame for excessively extending credit and investing in mortgages and loans, causing a liquidity mismatch and systemic failures.

“A run on the bank is driven by emotions. There may be nothing wrong with the bank except they don’t have the cash at the moment,” says Professor Bain. “Whether or not a bank has a true problem, lack of liquidity may kill it.”

Liquidity is not the only risk that the banks have to deal with. Default or credit risk, and interest rate risk are among the main hazards, in addition to systemic risk, geopolitical risk, national disaster risk, and so on. “The banks are good at managing risk because the ones that are not, are bankrupt!” he adds.

During a luncheon talk in December 2023 titled “The Collapse of Silicon Valley Bank,” Professor Bain shared a fascinating story behind the recent banking crisis. With more than 25 years of experience in banking and financial services, he revealed insights into this historical event and its ramifications for the financial world.

Tracing the root cause

Before the crisis unfolded, US inflation hit record highs in 2021 and 2022 in the wake of the pandemic. The Federal Reserve, or the “Fed”, exacerbated the problem by inflating the money supply through excessive printing, with a resulting decrease in the currency’s value.

“Inflation was the result of a mismatch between supply and demand, and we ended up with rising prices,” says Professor Bain. “There was too much demand following the pandemic. Everyone started to go out and spend, fueled by huge government fiscal stimulus.”

To counter this inflation, the Fed decided to begin raising interest rates in March 2022, impacting the demand to reduce excessive spending and cool down the overheating economy.

A run on the bank is driven by emotions. There may be nothing wrong with the bank except they don’t have the cash at the moment. Whether or not a bank has a true problem, lack of liquidity may kill it.

Professor Thomas Bain

It’s worth noting that interest rates and bond prices move in opposite directions. By December 2022, Silicon Valley Bank held US$117 billion in securities, representing most of its US$211 billion in assets. As the Fed raised interest rates, these bonds exhibited considerable losses. A few stock traders picked this oddity and then turned to social media to voice their concerns, and the rest is history.

“Looking at Silicon Valley Bank’s balance sheet, it’s losing value because the value of the bonds that it bought is falling because of rising interest rates,” Professor Bain adds.

The top gainers

Learning from the Great Depression, the Federal Deposit Insurance Corporation (FDIC) was created in 1933 to insure the depositor’s funds up to US$250,000 per insured bank. Nevertheless, the majority of Silicon Valley Bank depositors boast substantial wealth, with deposits far exceeding the FDIC insurance limit.

A moral hazard occurs when an economic actor increases its risk exposure without bearing the full associated costs.

These investors funnel large sums into various startups and venture capital funds, utilising the bank as a temporary repository for their funds. In a strategic move to stop bank runs, the government swiftly intervened in the wake of the Silicon Valley Bank collapse, assuring all depositors that 100% of their funds were fully insured.

“Insuring all of the deposits was good for those depositors but bad for everybody else,” says Professor Bain. “How is the FDIC going to pay for that? From tiny extra insurance premiums that ultimately everyone else has to pay. The whole country’s insurance rates went up a fraction to pay for this.”

Soon after the FDIC disclosed its plan to insure all the Silicon Valley Bank depositors’ money, many news outlets, including the New York Post and USA Today, reported that the now-defunct banks—Silicon Valley Bank and Signature Bank—made political contributions to the US Democratic Party between 2017 and 2022 through their employees and affiliated political action committees. With an election coming in 2024, the current administration has a very good reason to save Silicon Valley Bank depositors, who presumably would contribute to the campaigns.

“Now here comes the moral hazard, because now they can put as much as they want in the bank since if there’s a problem, the FDIC will rescue them,” he adds. A moral hazard refers to a situation where an economic actor is motivated to amplify its risk exposure as it does not bear the full costs associated with that risk.

Furthermore, the depositors that managed to withdraw moved their funds to the big four banks—JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup—boosting their profits up to 23 per cent by the third quarter of 2023. Meanwhile, other banks fell by 19 per cent in the same period.

Despite the optimistic projections, Professor Bain warns of a bearish market in the US and the potential for a recession.

The four top lenders now accounted for 45 per cent of all industry profits in the country, which consists of almost 4,400 banks. This is a significant rise from the previous year at 35 per cent and a 10-year average of 39 per cent.

What’s next?

As the US government keeps ramping up its spending, the Fed has been printing money and acquiring a substantial amount of bonds, resulting in its balance sheet almost reaching US$8 trillion in October 2023. This collaborative effort has contributed to the formation of a significant inflationary bubble.

For more than a year now, the Fed has been shrinking its balance sheet to help control inflation, causing interest rates to rise.

“I think there has to be a recession, maybe not a major one,” says Professor Bain. “We’re thinking of negative GDP growth. The economy will start to contract.”

In late March 2023, the US experienced a “yield curve inversion,” which hadn’t occurred since 2019 and has historically foreshadowed economic downturns. The yield curve represents the interest rates investors demand when lending money to the government for different periods.

“It doesn’t mean that every time the yield curve is inverted, we have a recession, but every time there is a recession, the yield curve inverts!” Professor Bain adds.


What and how to disclose when facing banking crisis

Although the US economy increased by a significant 5.2 per cent in the third quarter of 2023, many see it as a huge government fiscal bubble. In real life, Professor Bain observes that people are now running up debt and have no cash to spend.

“Inflation has made food and spending so high that people are running up their credit cards. You can see the debt levels rising,” says Professor Bain. “This also creates more impetus towards what I believe will be a recession in the US and maybe more banks will need rescuing as a result.”