A banking crisis on both sides of the Atlantic has triggered fears about the health of the global financial system in 2023, with two of the biggest banking failures in US history and the rushed rescue deal for embattled Swiss outfit Credit Suisse sending shockwaves through the markets over the past two weeks.
But how did it happen and what comes next?
Why did Silicon Valley Bank collapse?
The Federal Reserve and other central banks have hiked interest rates to their highest level since the 2008 financial crisis as they try to contain persistently high inflation, but this made life more difficult for many of Silicon Valley Bank's clients, dominated by fast-growing but often loss-making businesses that still require lots of cash to keep going.
Rising rates led to venture capital drying up and made it more expensive for clients to borrow money, forcing them to tap into their deposits. SVB struggled to keep up with the pace of withdrawals, which left it short on the cash it needed to fulfil all the requests.
To plug the hole, it sold a chunk of its investment portfolio. The problem was, it sold it for a $1.8 billion loss because the portfolio included bonds that had lost a large amount of their value thanks to higher interest rates reducing their yields.
SVB was in a tight spot because over half of its total assets were in its investment portfolio after the bank decided to turn deposits, which customers can redeem on demand, for held-to-maturity bonds that needed to be kept for the long-term. Importantly, those bonds would have proven profitable if they were held to maturity but SVB was pushed to sell at a loss as more deposits were withdrawn, especially as it had not undertaken sufficient interest rate hedging.
The fiasco prompted SVB to try and raise fresh capital to bolster its balance sheet but this was ultimately unsuccessfully. The move set off a siren that the bank was financial unstable and led to some influential venture capitalists telling the businesses they were invested in to start pulling their money from SVB, which only exacerbated the situation. Clients didn't want their money in SVB and investors didn't want to throw good money after bad.
Unable to raise fresh cash or find a buyer quickly, SVB was closed by regulators on Friday March 10, 2023. It is the second biggest bank failure in US history, and the largest collapse since the 2008 financial crisis. SVB was the 16th largest bank in the United States that had over $200 billion of assets and $340 billion of client funds on its books at the end of 2022, predominantly from fast-growing startups in areas like tech and healthcare. In fact, SVB was the bank of choice for nearly half of all US venture-backed startups.
Why did Signature Bank collapse?
Another domino fell just two days after SVB was closed when Signature Bank was shut down by regulators. This was the third largest banking collapse in US history after Signature also struggled to cope with a rush of withdrawals from clients, which only worsened as news of SVB's failure ripped through the markets and caused Signature's clients to panic.
Like SVB, virtually all of its deposits came from businesses and around 90% of them at both banks were uninsured, meaning they were not covered by guarantees provided by the Federal Deposit Insurance Corp (FDIC). That left deposits vulnerable if the banks fell into trouble, encouraging clients to shift their money out and into more financially-stable institutions.
That may have drawn the eye of regulators that were scrambling to find other vulnerabilities in the system following the demise of SVB, leading to the abrupt closure of Signature Bank on March 12, 2023.
What will happen to SVB and Signature Bank?
Both SVB and Signature Bank were placed under the control of the FDIC after being closed by regulators. The FDIC is now responsible for finding buyers to take on the assets of the two failed banks, while keeping both companies operational in order to serve clients in the meantime.
Will First Citizens bid for SVB assets?
Attempts to find a buyer for SVB's assets has proven fruitless so far. That has prompted the FDIC to break the bank into two and hold separate auctions for the arm that holds its deposits and its private bank catering to high net-worth clients.
First Citizens BancShares, known for snapping up parts from collapsed banks, is reported to have submitted a bid for the entire bank and is willing to purchase parts if necessary, according to Reuters.
New York Community Bank buys Signature Bank assets
Meanwhile, New York Community Bank has already stepped up to buy substantially all of Signature Bank's deposits and nearly $13 billion in loans, sending the share price soaring after securing them at a discount to make it among the few banking stocks trading higher now than it was before the crisis started. The assets are being taken over by NYCB's subsidiary Flagstar.
That leaves the FDIC looking for a buyer for about $60 billion worth of Signature Bank loans, bonds and other assets – including Signature's cryptocurrency unit Signet.
What about the collapse of Silvergate?
It is worth noting that another bank, Silvergate, was actually the first to buckle after crumbling just days before SVB. The bank, known for its close ties to the cryptocurrency market, entered voluntary liquidation after its balance sheet succumbed to a rush of withdrawals as depositors demanded their money back. It was also being plagued by an investigation by the US Department of Justice over transactions with the now defunct FTX and Alameda Research, both of which rocked crypto markets after imploding last year.
Unlike SVB and Signature, the bank was not rescued by regulators but instead entered voluntary liquidation and started to wind down operations, pledging to fully repay deposits.
Liquidity crisis spreads to US regional bank stocks
Fears of a broader banking crisis quickly started to spread as markets fretted more businesses and consumers would start withdrawing their money from smaller institutions in fear they could lose their cash.
A bank run is self-fulfilling in nature – fear of it makes it happen and creates a flywheel effect that sees the withdrawal of deposits accelerate, escalating the problem and quickly making it a much bigger issue for the wider financial system.
This sparked fears for smaller regional lenders in the US and hit the shares of stocks like Western Alliance, East West Bancorp, Fifth Third Bancorp and KeyCorp.
Will the big banks save First Republic?
One of the hardest hit regional banks has been First Republic. Clients started taking their money out of the bank and placing it into larger, more financially-stable banks as the threat of contagion mounted.
That left First Republic short on cash and in need of a lifeline. Fortunately, a group of the largest US banks comprised of JPMorgan, Bank of America, Citigroup and Wells Fargo stepped-up and pledged to take $30 billion of their deposits and inject it into First Republic to strengthen its finances and send a message that the banking industry was strong and working together.
Unfortunately, that hasn't been enough to save First Republic. Media reports suggest it is now weighing up all of its options, including a potential sale to a larger rival. This would be from a distressed position considering its weak liquidity position has led to First Republic being downgraded to junk status by ratings agencies.
Bloomberg has reported that JPMorgan is considering a new rescue plan for First Republic that could see some or all of that $30 billion in deposits be turned into equity to provide the troubled bank with fresh capital.
What caused the Credit Suisse crisis?
It didn't take very long for the threats facing the US banking system to spread over the Atlantic and ripple through Europe.
At the forefront of the troubles on the continent is Credit Suisse. The 167-year old bank, a big player in Europe and the second largest lender in its home country of Switzerland, was already seeing clients withdrawing their money last year as they become increasingly worried about the state of the bank, which has been ensnarled in a series of scandals and legal problems over the years – from being caught up in the Greensill Capital debacle to the fall of Archegos Capital.
That left it extremely vulnerable as clients responded to the chaos in the US and started taking action to protect their money.
Things got worse when Saudi National Bank, which has a 10% stake in Credit Suisse, said it would not provide any more financial assistance to the bank because regulatory rules wouldn't allow it to increase its stake. That spooked investors and clients even further as it signalled raising equity would be difficult and that major shareholders would not emerge as Credit Suisse's white knight if called upon.
The subsequent drop in equity, with the share price having hit all-time lows, and of its bonds, with the cost of insuring them against default hitting dangerous levels, prompted Credit Suisse to open discussions with regulators on Wednesday March 15, 2023.
That resulted in Credit Suisse becoming the first major global bank to secure an emergency lifeline since the last financial crash as regulators agreed to provide a CHF50 billion ($54 billion) liquidity facility to ensure it had the cash it needed to cover deposits.
UBS to takeover Credit Suisse
The Swiss National Bank moved quickly to provide as much certainty as possible and said it would provide all the liquidity necessary to keep Credit Suisse going. In the meantime, it was holding talks with the largest lender in Switzerland, UBS, and encouraging it to take its smaller rival under its wing as the lifeline failed to prevent Credit Suisse's share price plunging further.
Swiss president Alain Berset said the outflow of funds from Credit Suisse meant it was 'no longer possible to restore market confidence' and that the takeover by UBS was necessary.
UBS, despite reports suggesting it was reluctant to complete a merger with its beleaguered peer, agreed to take Credit Suisse over on March 19, 2023.
UBS low-balled its first offer and said it would pay just CHF0.25 on the day that SVB collapsed but this was rebuffed by Credit Suisse, which balked at the $1 billion price tag. UBS returned with an improved offer of CHF0.76 a share in stock, tripling the value to CHF3 billion. It also agreed to assume CHF5.4 billion in losses as part of the deal after the Swiss government provided a loss guarantee for an even larger sum of around CHF9 billion.
UBS has said it will remain 'rock solid' after it buys Credit Suisse. It plans to downsize Credit Suisse's investment banking business in order to reduce risk and align it with its more conservative approach. That plan will be welcome in the current environment. For Credit Suisse, which at its peak was once worth almost CHF75 per share, it is has proven to be a slow and painful end.
UBS shares initially took a hit over fears it was taking on trouble, but have swiftly rebounded as markets warm to the addition considering the price tag and the fact the deal cements UBS as the largest wealth manager in the world.
Will more banks collapse?
We have seen unprecedented action taken by central banks, regulators and government officials in the past two weeks as they try to stamp-out the threats facing the global financial system and the contagion spreading through the markets.
US Treasury secretary Janet Yellen announced just today that that the department is willing to provide more support to try and calm market jitters over the state of the banking sector if necessary.
'The steps we took were not focused on aiding specific banks or classes of banks. Our intervention was necessary to protect the broader US banking system,' Yellen is set to say at the American Bankers Association conference later today. 'And similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.'
The Federal Reserve has already provided extra financing to the banking industry and officials are considering the idea of temporarily expanding insurance over all deposits. Currently, the FDIC insures deposits up to $250,000, but the idea has been floated to increase this and provide new protections for uninsured deposits. The hope is that deposits will stabilise and the action already taken will be enough, but there has been a strong signal that authorities are prepared to introduce more supportive measures if markets demand it. Others, such as the Swiss National Bank, have sent a similar message to restore faith.
US officials have stressed that the actions taken over SVB and Signature Bank have been taken to stop the problem from spreading to other institutions and protect depositors, but have refused to call it a bailout. Instead, it says shareholders will be wiped out. Meanwhile, Credit Suisse, a larger behemoth regarded as one of those potentially 'too big to fail', has been thrusted upon its more disciplined rival UBS, while bondholders will also lose out after the value of Credit Suisse's additional tier-1 bonds were written down to zero.
The situation will improve for any banks still feeling the pressure if markets calm down and depositors grow more confident about the security of their cash. We have seen a broad rebound in banking stocks today but most remain much lower than they did a week or two ago, and markets are eagerly keeping an eye out for any new signs that another domino will fall. Confidence remains fragile and it won't take a lot to revive the haunting memories of the last financial crisis – and we are yet to see how it will impact the path of interest rates….
Banking crisis: What does it mean for interest rates?
Higher interest rates have contributed to the stress being applied to the global financial sector and this is raising questions about the strategy of central banks. Raising rates is the primary weapon wielded when battling inflation, which is proving persistently high and is still way above ideal levels.
However, with rates also putting the global banking system under strain, markets believe central banks could slow or even pause rate increases, providing more time for economic data to show the impact existing hikes have had, to provide some stability and ensure they don't put the system under further pressure.
Source: Forex.com