In recent weeks, the world has witnessed the collapse of several banking institutions, including Silicon Valley Bank, Signature Bank, and nearly, Credit Suisse. Silicon Valley Bank’s collapse marked the largest US bank failure since the 2008 financial crisis. Signature Bank and Silvergate Bank also collapsed earlier this year after exposure to toxic situations. Credit Suisse’s downfall took the headlines as Switzerland’s second largest bank had to be bought out of distress by its Swiss competitor UBS. The crises within the banking sector has raised concerns about the stability of the global financial system and the possibility of another devastating financial crisis. This article explains why the world is at risk of another financial crisis following the recent banking crises in the US and Switzerland.
What happened in the banking sector?
The recent banking troubles nearly led to a financial crisis, with Credit Suisse being at the forefront. Three US banks collapsed in March 2023 in just 5 days, namely, Silicon Valley Bank, Silvergate Bank and Signature Bank.
Silicon Valley Bank’s (SVB) collapse caused a huge shockwave across the tech sector. The lender had over $200 billion in assets and provided a range of financial services for leading tech companies. It financed nearly 50% of all venture-backed tech and healthcare companies. SVB was hit by the rapidly rising interest rates and the consequent decline in value of bonds that it held. Poor risk management and governance was also blamed for its collapse.
Both Signature Bank and Silvergate were fatally impacted by the collapses of larger institutions. Signature Bank was heavily affected by the collapse of Silicon Valley Bank as customers were nervous about the financial stability of the bank. Customers then withdrew over $10 billion in a week and ultimately the bank failed and was shut down by US regulators. Silvergate had significant exposure to cryptocurrencies and, most fatally, to failed cryptocurrency exchange FTX (see previous top 10). FTX’s collapse triggered customers to withdraw a huge $8 billion in deposits during Q4 of 2022 alone, leading Silvergate to a $1 billion loss and ultimately its demise.
Credit Suisse however, took the headlines, as Switzerland’s second largest bank fell into distress. The bank has been in trouble for the past few years after being plagued by scandals. CEO Tidjane Thiam was ousted in 2020 after the company was found to have spied on former employees. In 2021, it lost $15 billion from the collapse of Greensill and Archegos (see previous top 10). Later in the year, it was fined $475 million for bribery in Mozambique. Credit Suisse’s stock price plummeted, and it was forced to suspend its share buyback program and cut its dividend. Ultimately, UBS had to purchase Credit Suisse for 3 billion Swiss francs (£2.6 billion) to prevent bankruptcy, in a deal brokered by the Swiss government.
The collapse of the three US banks significantly harmed their creditors and customers. Had Credit Suisse fallen into bankruptcy however, it would have been catastrophic on a global scale. The initial impact would have seen customers withdrawn their funds fearing that other Swiss banks could also soon collapse. This could have created a domino effect on the thousands of Credit Suisse bondholders, clients and counterparties across the globe and this ultimately could have led to another financial crisis.
How easily could another financial crisis happen?
Another financial crisis similar to 2008 is a very real possibility given how easily the collapse of one large bank could wreak havoc across the global financial system.
The 2008 financial crisis occurred because banks’ leverage ratios were too high. In other words they owed significantly more money than they had in the bank. When the subprime-mortgage crisis hit, banks were unable to withstand the shock. Lehman Brothers for example, had a leverage ratio of 30:1 ($30 owed for every $1 cash it had) before its collapse. So when it collapsed, the $619 billion of its debt owed to creditors was largely written off. This caused contagion as other banks who were relying on payment from Lehman were now strapped for cash. This is why it was critical that Credit Suisse did not fail. The bank has over $500 billion in debt. If Credit Suisse was not able to meet its obligations and went bankrupt, it could have sparked a series of collapses across the world, particularly amongst creditors who are highly dependent on their relationship with Credit Suisse.
Credit Suisse’s case clearly proves how easily another financial crisis could occur as its collapse was not driven by an extraordinary event. Clients were simply concerned about Credit Suisse’s financial position and withdrew funds en masse. These concerns were, of course, compounded by years of scandals and poor management. But fundamentally, no financial institution is immune from scandals or poor financial performances which could lead to client mistrust. The case of Credit Suisse shows that a shock event like the 2007 subprime mortgage crisis is not needed to cause a large collapse and then potentially a global financial crisis.
Potential Solutions
A new severe financial crisis is not an inevitability. Proactive regulation is the only way to prevent a financial collapse. Monitoring and engaging with problematic banks who show signs of shakiness before they’re in distress is more important than ever.
The UK’s Financial Conduct Authority for example, updated its approach to supervision after the financial crisis. They “aim to pre-empt or address poor conduct so that risks do not arise and any associated harm does not materialise” or at least ensure “significant harm” is not caused to consumers of the UK financial system. They have also introduced more detailed conduct risk frameworks to ensure firms maintain higher standards of conduct internally. Prevention is always better than a cure.
Fundamentally, maintaining adequate cash reserves is the best way to prevent bank collapses and therefore, financial crises. Basel III is an international framework introduced after the 2008 financial crisis to set minimum liquidity levels for all international banks. Banks must maintain a certain level of cash in its reserves in relation to its debt. This ensures that banks can stay afloat even if there is a run on the banks. Banks are now much better capitalised than in 2008 and have more reasonable leverage ratios.
Central banks such as the Bank of England, also now run stress testing to see how banks would fare financially if a hypothetical external shock event took place. This can include things such as a severe drop in house prices, a significant natural disaster or a crash in stock markets. If banks are not well capitalised enough to withstand these shock events, the regulator would then obligate them to build up their cash reserves. Some criticise these tests as too onerous as they unduly restrict banks ability to issue credit. In any case, recent events show that the stress testing regimes will always need to adapt to prevent or mitigate the impact of future collapses. As long as such adaptation happens, there is every chance that a severe financial crisis can be averted.
Conclusion
The recent banking crises have highlighted the vulnerability of the global financial system to systemic risks and the need for better risk management practices and regulatory reforms. The recent crises show us that we are closer to a new financial crisis as politicians and regulators would like us to believe. The banking sector is the core of the global financial system, and modern life so failures in this sector could have severe consequences for all of us. While there is no guaranteed way to avert a financial crisis, implementing proactive regulatory reforms and better risk management practices can help mitigate the risks and prevent another deep financial crisis.
