The collapse of Silicon Valley Bank (SVB) in California on 10 March, may not have triggered a fully fledged banking crisis, but it certainly left a fire smouldering, a spark from which then caught the systemically important 167-year-old Credit Suisse.
The jitteriness across markets following the toppling of the Swiss bank was even more pronounced, although it can be argued that SVB caused the greater harm. Credit Suisse was always going to face a reckoning after years of scandals and problems, and it finally came. Now it has been scooped up by its erstwhile rival UBS in a deal that creates a giant new entity.
A second US bank also capsized and a third, First Republic, continues, at the time of writing, to list badly despite being bailed out by bigger rivals on Wall Street. But a mix of emergency rescues, bailouts and liquidity injections along with assurances of resilience and stability from regulators would seem to have saved the day (and delayed again the return to “normally” functioning markets).
The fact that the sinking of these banks can be explained away – by high and unhedged exposure to long-duration assets, susceptibility to depositor flight or their history of scandals unrelated to the current macro environment – suggest that the crisis can be contained. Plus the key difference this time is that banks are well-capitalised. Tight regulation, close supervision and stress tests are paying off and should keep the bigger banks on dry land.
Pantheon Economics says everything points to stress levels being low among UK banks so far: “None of the main UK banks has been mismanaged like Credit Suisse or have acquired a large destabilising pool of fixed income securities like SVB.”
But if a major crisis has been avoided, the stress in banking is bubbling up in other ways. Investors with direct holdings in banks or through funds will have brushed up against the violent swings in values in the past two weeks. The normal hierarchy of who’s first in line to suffer losses when a company fails has potentially been inverted, which has implications for institutions raising capital.
But the biggest, and potentially most problematic fallout from the crisis has been in the form of a setback in the inflation battle. Although some of the risk posed by banking stresses had eased ahead of central banks’ decision on rates this week, they still faced a difficult question: should they keep fighting inflation hard or draw back for now, given how rate hikes have contributed to the crisis and the probability that chunky rises now could make things much worse? Monetary tightening “needs to be carefully calibrated now to avoid the risk of higher rates ultimately unearthing new dangers to the broader financial system” warned S&P Global.
Markets were quick to predict that the banking crisis would take precedence, and the Fed duly delivered, opting for a 25 basis point rise instead of the previous expected 50-point rise.
The Bank of England followed suit with its own quarter-point rise. It couldn’t really have done anything else in the wake of shock inflation data for the UK this week which revealed that inflation had snapped out of its downward trend to hit 10.4 per cent in the year to February, well above the expected 9.9 per cent, while core inflation had risen to 6.2 per cent, up from 5.8 per cent.
Even if central banks decide to tread more cautiously, opting for gentle hikes, it may not matter too much. Banks may now be inclined to tighten up on lending, something that will dampen both economic activity and property prices. And bank profitability will be impacted if they need to pay depositors more to persuade them not to withdraw their cash. On that point, some good could come from the whole calamitous event. One way to reassure jumpy savers with more than £85,000 on deposit with one provider would be to raise the level of protection provided by the Financial Services Compensation Scheme closer to the $250,000 offered in the US (and notably, the protection offered on securities is twice that).
