TODAY’S banking crisis differs markedly from the US subprime mortgage debacle that sparked the global financial crisis in 2008. But there are some common threads. The mantra of “too big to fail” continues to resonate. This is the conviction that some banks are too large and too intertwined with economies, and hence cannot be allowed to fail for fear of systemic risks.
Related to this is the question of moral hazard, which haunts regulators and the banking industry. As much as Swiss finance minister Karin Keller-Sutter insists that the takeover of Credit Suisse by rival UBS is “no bailout” and is a “commercial solution”, UBS was clearly the reluctant buyer, with the government – including the Swiss National Bank (SNB) – in the driver’s seat. Backstops for the three billion Swiss franc (S$4.3 billion) deal include continuing access to SNB facilities, as well as downside protection to cushion the costs of restructuring and the unwinding of non-core assets.
To be sure, the circumstances that caused Credit Suisse’s failure are to a degree unique – lax controls on risk-taking that showed up in a litany of scandals, ranging from a money laundering conviction to ill-fated investments in Archegos Capital. But it shares in common with all banks the challenging backdrop of the rapid escalation of interest rates over the past year. The unprecedented pace of rate hikes – 450 basis points over 12 months since March last year – not only forced a revaluation of all risky assets and risk-taking activity, but also exposed weaknesses in governance and accounting.
The upshot of all this is that banks lost clients’ confidence, the glue that binds financial systems, which then sparked massive withdrawals in the US. As for Credit Suisse, the erosion of client confidence began last year, escalating in the fourth quarter with over 100 billion Swiss francs in outflows.
What’s next for the global financial system? In the aftermath of the bank failures, the question of whether more regulation is needed will inevitably arise. Since the 2008 crisis, regulations have been put in place to forestall another crisis. These include the Dodd-Frank Act in the US, which requires banks to hold enough cash and conduct stress tests. Tellingly, Silicon Valley Bank successfully lobbied to be exempt from certain measures. Globally, there is also Basel III, which imposes liquidity rules for banks.
Arguably, there is already enough regulation. Adding more would only raise banks’ compliance burden. For the wider economy, more regulation could stifle the flow of capital to corners of businesses where it is most needed. Quick action by regulators in the US and Europe appears to have limited the fallout for now.
GET BT IN YOUR INBOX DAILY
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
Some trends are likely to emerge. One is a reinforcement of regulators’ powers to mitigate bank implosions and ensure the smooth functioning of financial systems. Liquidity backstops, for instance, are essential, as well as deposit guarantees. Two, credit supply is set to tighten and the cost of credit may rise as banks review their risk books. This comes just as higher rates are biting, and may well deepen any economic recession.
As for the question of moral hazard, regulators tread a fine line while appearing to tilt in favour of regular depositors. Ultimately, when banks fail, someone will pay. But whether it’s taxpayers, junior bondholders or shareholders, the burden is unlikely to be evenly spread out.
Keyword added to your list