Bank failures: what lies ahead?

Richard Plaistowe, Principal, Financial Services on what is going on in the banking sector following the high profile collapses of SVB and Credit Suisse. 

In a speech to the American Bankers Association on 21 March, US Treasury Secretary Janet Yellen was at pains to point out that the US banking system “remains sound” and that the situation was stabilising following the collapse of Silicon Valley Bank (SVB) and Signature Bank. Yellen talked about the government’s emergency rescue of the banks’ depositors and said similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.

SVB is the biggest US banking failure since 2008, the year of the global financial crisis, and the US government was impelled to act after the bank was hit by the withdrawal of $42 billion in deposits in a single day. An unsustainable haemorrhaging of money.

Two days earlier in Europe, troubled Swiss investment banking giant Credit Suisse was snapped up by its great rival UBS after its largest investor, Saudi National Bank, refused point blank to throw more money at propping it up. The acquisition came at the behest of the so-called “trinity” of the Swiss National Bank, regulator Finma and the Ministry of Finance who collectively made it plain not only that the deal had to happen, but that it should be announced on the Sunday evening ahead of the opening of Asian stock markets to reassure jittery investors.

The alternative course of action, a wind-down of Credit Suisse overseen by the Swiss government, was dismissed as a potentially disastrous option that posed the danger of spreading financial contagion – that unpleasant word again – across the globe. It would also have inflicted severe damage on Switzerland’s famous wealth management credentials. As it stands, they have been somewhat tarnished.

What are the wider implications of it all? Are we in the midst of a new banking crisis?

The situation is certainly rocky, as the nervousness around Deutsche Bank Illustrates – albeit that many analysts take the view that last week’s share sell off was an irrational move by markets. However, some US banks face the same risks that caused SVB’s downfall: a large number of uninsured depositors, coupled with a decline in the market value of their assets due to rising interest rates.

In the year to early March 2023, the market value of SVB’s assets declined by nearly 16%, or $34 billion. However, Stanford Graduate School of Business research finds that 11% of US banks have worse unrealised losses than SVB. Those among them that also have a significant base of uninsured depositors are obviously a cause for concern. Policymakers and regulators are focusing on this problem in a concerted effort to prevent a bank run, as per Yellen’s speech. It’s likely there will be further failures, but there are grounds for optimism that these would be containable.

As for Credit Suisse, even the FT referred to it as a “basket case” bedevilled by a series of scandals, including its risky exposure to collapsed US hedge fund Archegos Capital Management and involvement in the Greensill scandal, for which it was censured last month by Swiss regulators. While its $3.2 billion rescue by UBS has prevented a meltdown, there are tricky ramifications nonetheless.

The merger has created a mega-bank with assets twice the size of the Swiss economy. Job cuts are a certainty and the longer term impact on the bond market remains to be seen following outrage among Credit Suisse bondholders after $17 billion of its bonds were wiped out as a condition of the UBS rescue.

Added to this, interest rates continue to rise. The Bank of England’s latest hike from 4% to 4.25% on 23 March in a bid to quell inflation came the day after the US Federal Reserve also upped rates by 0.25%, its ninth consecutive rate rise. Clearly, this adds further fuel to the issue around unrealised losses outlined above.

Inflation and rising interest rates have also put an end to the extraordinary post-Covid surge in private equity dealmaking, notes leading management consultancy Bain & Company in a recent private equity outlook. This slowdown in investment will cause funding problems for some PE-backed businesses in fintech and other sectors.

But I don’t want to sound unduly pessimistic because the current climate will create opportunities too. In M&A, where it may be possible to acquire some good businesses at a comparatively low cost, expert interim management support will be required to help cement the value of some of these mergers. And given that markets are volatile and regulators eagle-eyed, there will be a wave of interim opportunities in the risk and governance space.

The storm clouds are gathering, but they do have a silver lining.