by Philip Pilkington
Monday, 20
March 2023
Chart
07:00

Are we about to enter a full-scale banking crisis?

The international monetary system is looking increasingly shaky
by Philip Pilkington
The KBW Bank Stock Index (BKX) paints a worrying picture

When is a banking crisis a banking crisis? These past few days we have seen the failure of multiple banks. The action started with Silicon Valley Bank and soon spread to Signature Bank, making those two the second and largest bank failures in American history respectively. Significant pressure has also been felt on other institutions, like First Republic.

However, the crisis has now gone international, with UBS agreeing an emergency rescue deal with Credit Suisse. While Silicon Valley Bank and Signature Bank had their own idiosyncrasies in the tech sector — with oversize deposits held by venture capitalists in the former and cryptocurrency exposure in the latter — Credit Suisse was simply a normal international bank with some structural weaknesses.


Like what you’re reading? Get the free UnHerd daily email

Already registered? Sign in


Its failure thus raises the prospect of a more general banking crisis of the sort that we saw in 2008. It indicates that the tech banks may have just been the weakest dogs in the pack and now the problems are spreading to more established banks. Does that mean we are now in a full-blown crisis?

Typically, economists and regulators view a true banking crisis as one in which there is systemic failure. That is, when the failure of one or more banks starts to spread to the system as a whole. The failures of the banks we have seen so far are related, but they are not interconnected. They are all caused by the pressures that rising interest rates are putting on the banking system but, importantly, they are not linked to one another and thus not truly part of a systemic issue.

Yet certain indicators are flashing bright red. For example, the KBW Bank Index (pictured above) — the index which tracks banking stocks — has collapsed by more than 30% in just over a week. Other indicators are more reassuring: the TED Spread — which tracks the rate at which banks lend to each other — is still muted.

What may explain this discrepancy is the huge spike in liquidity that the Federal Reserve is pumping into the system through the discount window. The discount window allows banks to borrow a potentially infinite amount of liquidity on a short-term basis to stymie banking crises. Its use tends to come with penalties and so banks avoid using it. But the recent data suggests that the Federal Reserve may be using the window to engage in a sort of surreptitious bailout.

So it appears we are not in a banking crisis — yet. It does appear to be incipient, and the smart money says that when chaos starts in the banking sector, it usually spreads. Indeed, there are some notable ructions occurring in the system, with record outflows of deposits in banks and into money market funds. The coming days and weeks will determine whether this wave of bank runs is some short-term turbulence or, rather, the start of the real thing.

One area to watch which is currently getting scant attention is the mortgage market. House prices have been falling since at least the summer, and the wave of bank failures may lead to lenders becoming more conservative in their lending. This would entail a collapse in both the demand for and supply of credit for home purchases, which could instigate a cascade effect where homeowners are forced into negative equity and, from there, into default.

The system is looking shaky, but it’s holding — for now.

Join the discussion


To join the discussion in the comments, become a paid subscriber.

Join like minded readers that support our journalism, read unlimited articles and enjoy other subscriber-only benefits.

Subscribe
Subscribe
Notify of
guest
24 Comments
Most Voted
Newest Oldest
Inline Feedbacks
View all comments
Stephen Walsh
Stephen Walsh
2 months ago

Our betters have created a financial system which cannot function without the crack cocaine of super low interest rates. So interest rates will not now rise as much as would be required to tackle inflation. So there will be inflation, or rather stagflation. With all all the painful and dangerous political consequences of that.

Walter Schwager
Walter Schwager
2 months ago
Reply to  Stephen Walsh

Peter Thiel started the ball rolling

Nicky Samengo-Turner
Nicky Samengo-Turner
2 months ago
Reply to  Stephen Walsh

That is a very simplistic, and far from accurate view

Nicky Samengo-Turner
Nicky Samengo-Turner
2 months ago

This is a highly complex subject that does require deep knowledge of, and training in, capital markets economics, as well as actual industry experience, which current incumbents at The Bank of England and HM Treasury do not appear to have, not least because
a. They will not pay an adequate rate to employees with that necessary expertise,
and..
b. Both appear obsessed with ” Diversity and inclusion” hiring policy.

The exponential growth of what was originally a hedging tool, via futures and options in the commodity markets, mainly agricultural, and insurance ( where a premium is essentially a margin call on a put/ call event) i. e. the derivative, has completely altered the capital markets and commodities industries.

Out of this phenomena have come proprietary trading, and hedge funds, using margin leveraged borrowing, and synthetic derivatives, whereby, in laymans terms, and to use horse racing anology, a ” punter” can pick a range of quasi ” accumulator” bets on a basket of stocks/bonds/ currencies/commodities going up and/ or down.

Such is the power of the leaders in this part of the capital markets industry, that they have a plethora of counterparties who will, or indeed have to, take the opposite position so as to ” defend/ prop up” the stock/bond/ commodity/ currency that is under attack.

The advent of index/ tracker funds which sell into falling markets/ buy into rising markets, has only magnified the opportunity for prop/hedge/ vulture funds to effectively win their bets.

Elliott Bjorn
Elliott Bjorn
2 months ago

You do not need all that vu-du explanation. The Central Banks created Trillions of QE. QE basically being Bank Reserves. They do this to stimulate, by giving banks reserves to loan – and then so much QE buying debt keeps interest at Zero, also to stimulate.

So they have loads of money, and zero interest. So they buy Treasuries at almost zero interest. LONG term ones, and use them as their Bank’s collateral.

If you hold 10 year, and 30 year Treasuries or Gilts at 1% interest you are fine Unless they Raise Interest. The way Bonds work is if the ones you hold have lower interest than current interest their value (price) Plummets.

Exactly like Truss and the Gilts the pension funds held when she raised interest. They lost 20% of their value so the business could not meet their obligations.

Now there is another issue, Margin. That is borrowing to buy 10 times more bonds at 1% interest that you can afford – so you can get an actual income. But if the bonds drop in value because interest rises – you are cooked.

This is the game they played.

QE has destroyed the world finance. Who would have guessed –

Simon Simple
Simon Simple
2 months ago
Reply to  Elliott Bjorn

The banks are the canaries, the pension companies the mines?

Steve Jolly
Steve Jolly
2 months ago

“But the recent data suggests that the Federal Reserve may be using the window to engage in a sort of surreptitious bailout.”
Indeed, because the public backlash for bailing out the same banks a second time for basically the same reason would provoke a backlash almost as bad for the powers that be politically as an actual banking crisis that triggers a recession/depression. They’re screwed either way so of course they’re grasping at whatever straws are convenient to try to fix things without having to go to the Congress and the public again.

Dougie Undersub
Dougie Undersub
2 months ago

It’s not so much a banking crisis as a regulating crisis. The regulators have vastly increased the size of the rulebook and have come to believe that that in itself is all that regulation entails. They’ve been so busy ticking an ever-increasing number of boxes they’ve neglected to look under the bonnet.

Simon Simple
Simon Simple
2 months ago

In the UK Truss lifted the bonnet and the shock was such that the UK underwent a Coup and Sunak, former Chancellor now rules. I wonder if he ever looked under the bonnet?
It appears the BoE didn’t. I believe it was their pension company that has the most bonds and LDIs. Interesting conflict of interest there for the BoE boss? Do I save the Government or my pension provider?
https://www.efinancialcareers.com/news/2022/10/pay-bank-of-england
https://www.washingtonpost.com/business/markets-didnt-oust-truss-the-bank-of-england-did/2022/10/26/dd92c4d2-54eb-11ed-ac8b-08bbfab1c5a5_story.html
IF I were in Govt, it wouldn’t be the banks that kept me awake at night, it would be the pension funds. It appears that Italy isn’t the only place were a financial system doom loop with Government debt exists.
With Gold slowly dropping, and now under £1600+ an oz, there may be a chance still to acquire some, and so use that barbaric relic to save something from the coming mess. Then again, I could be wrong, I only know what I read and believe.

James Stangl
James Stangl
2 months ago

The author states:

Credit Suisse was simply a normal international bank with some structural weaknesses.

British understatement? Credit Suisse has been a basket case for years, with several major scandals to warn investors and regulators. While its sins were different from SVB or Signature, it was a poster child for troubled bank.

Kyle jones
Kyle jones
2 months ago

There doesn’t seem to be a lot of press on which companies brought SVB down or much detail on any of recent failures.

Simon Simple
Simon Simple
2 months ago
Reply to  Kyle jones

There is an interesting alternative view on SVB, Signature etc, but how true is moot. Perhaps it has some truth but in the vein of ‘a convenient coincidence’ for the Fed.
That rumour is that the Fed acted quickly to take down the major access points between Bitcoin’s world and the Government’s financial world. Why? So the Fed has less competition IF it introduces its own CBDC.
Personally if it wasn’t for the fact that the powers that be do seem incredibly incompetent (See Janet Yellen being interrogated by the Governor of Oklahoma,
https://www.youtube.com/watch?v=Bcvl104tyRY
she seems reluctant to accept she’s basically putting community banks at risk!)
I’d discard it because it strikes me that CBDCs as described to me will destroy the banking system.

Kyle jones
Kyle jones
2 months ago

As this article below indicates partly the issue is an accounting one (showing fair market value of T-bills on balance sheet and not notes) and partly then a run on the bank when depositors got scared. The accountants and overriding banking institutions should have had heads up.

https://blogs.cfainstitute.org/marketintegrity/2023/03/13/the-svb-collapse-fasb-should-eliminate-hide-til-maturity-accounting/.

Kyle jones
Kyle jones
2 months ago

So HSBC for £1 picked up good buy.

David McKee
David McKee
2 months ago
Reply to  Kyle jones

The devil, as ever, is in the detail. HSBC had to acquire the UK arm of SVB more or less sight unseen. I expect they are still going through the books to see if there are any unexploded land mines in SVB’s balance sheet.
ING picked up Barings for £1 nearly 30 years ago, but at least the Dutch knew they were acquiring a bank that was £800m in the red.
It’s even more dicey for UBS. Hence the huge sweetners the Swiss have thrown in UBS’s direction.

Nicky Samengo-Turner
Nicky Samengo-Turner
2 months ago
Reply to  David McKee

Actually they didn’t as proved when they sold Barings private equity fund plus all its AUM to management for £1 if I remember correctly, as obviously the £1 price included all liabilities…. which ING failed to ” get” was the portfolio into which Baring Private equity had invested.

Nicky Samengo-Turner
Nicky Samengo-Turner
2 months ago

PS Barings was a very different situation as the family holding Baring Foundation which owned Baring Brothers, kept its funds in tact by allowing the bank itself to become insolvent, rather than put ” good money after bad” – The merchant bank was not the problem, it was Barings relatively new stockbroking subsidiary Baring Securities that failed, as one employee was not ” broking” as an agency broker, but taking proprietary positions. The Baring bankers / board were in the main very against starting a stockbroker, and there was an element of ” told you so” in letting the stockbroker bring the Barings group down: the merchant bank, asset management and private equity arms were doing well.

J Bryant
J Bryant
2 months ago

Thank you. This is the type of insight/analysis I’d like to see in Unherd articles. There seems to be a fear on Unherd that if an article becomes at all “technical” then readers will hide under their desks.

Paula Adams
Paula Adams
2 months ago
Reply to  J Bryant

Not hide, swipe. But Unherd is a smart person’s magazine.

Nicky Samengo-Turner
Nicky Samengo-Turner
2 months ago
Reply to  J Bryant

Thank you: the staggering ignorance of capital markets on this medium appears to be no bar to individuals lemming like keenness to display that ignorance in writing!

Simon Simple
Simon Simple
2 months ago
Reply to  David McKee

Lloyds picked up HBOS, when HBOS’ own CEO appeared to have no idea of the mess it was in.

Nicky Samengo-Turner
Nicky Samengo-Turner
2 months ago
Reply to  Simon Simple

The erstwhile Bank of Scotland was by most measures, the best run bank in Britain, if not Europe. Its biggest shareholder was Standard Life, the big Scots life and pensions business: the bosses of BoS and Standard fell out, and Standard sold their stake to the grossly incompetent Halifax Building Society, who destroyed BoS- in hindsight, BoS could have done a capital raising deal to buy out Standard, but the bosses of each institution were at such loggerheads, they failed so to do- a real tragedy for an erstwhile superb bank.

Nicky Samengo-Turner
Nicky Samengo-Turner
2 months ago
Reply to  Kyle jones

but have any liabilities too

Vicha Unkow
Vicha Unkow
2 months ago

Low interest paid to savers , CDs,IRA, and low interest mortgages and easy credit with over several years lockdowns, job and business governmental stoppages didn’t help economic flow. Also the Democrats push to stop energy sectors, and NATO war manufacturing did our world a disservice.