Current banking crisis: Is the glass half-empty or half-full?


THERE is a common saying in economics that: "When the United States (US) economy sneezes, the whole world catches a cold".A look at the great recession of 2008, is ample testament to the importance of activities in the US, towards all other economies.

At that time, crisis in the US financial markets spread globally and led to one of the worst recessions in 80 years. The hub of the world's new found economic and financial problems were stemming from both unusually low interest rates and unsparing issuance of mortgage loans within the US domestic market.

As interest rates eventually rose, demand for housing and subsequent prices fell off a cliff, whilst borrowers could not continue with their mortgage repayments.

There was both a liquidity and credit crunch (shortage) in the US, which spread on to global interbank markets. The results were catastrophic, as, globally, people lost their houses, jobs and savings, or all three.

Global GDP fell by 1% and world trade fell by a staggering 10%. In South Africa, a recession was experienced for the first time in 17 years. The recovery from that steep decline was long and prolonged, as it took 18 months for the US to retain its upward trajectory, for instance.

Fast forward to 2023, the months of March, April and May have had echoes of 2008, as some notable regional banks, in the U.S. have collapsed, causing widespread concerns of whether this will spread to the overall domestic banking sector and abroad.

With such a background, the fretting is justified and there is a need to bring clarity to the nature of risk and possibility of another US and global financial crisis.

It becomes vital to shed more light on each of the recent bank failures, resultant interventions provided by the US banking authorities, outstanding threats and the eventual determination of how much risk awaits the domestic and global financial markets at this stage.

Ultimately, the objective is to discern whether the proverbial "glass" of turmoil in the financial markets is half-empty, meaning, official responses to the problem are depleting the crisis, or it is half-full, as an indication that the situation will continue and eventually spill into a full-scale catastrophe.

Currently, four key banks have failed in the US, in the short space of time, from March to May. These are Silvergate Bank, Signature Bank, Silicon Valley Bank (SVB), and First Republic Bank.

The latter three have become the second, third and fourth-largest bank failures in the history of the U.S., all just under Washington Mutual, which folded in the 2008 crisis.

It is also notable to articulate that the recently collapsed banks are regional financial institutions, unlike the gargantuan national banks, such as JP Morgan Chase Bank.

However, those regional banksused to provide about half of the commercial lending in the US.Thus, their demise will curtail availability of credit in the market. In the midst of already high interest rates, this portends a recession, anytime from Q4, 2023.

Before narrating the activities leading to the failure of the four banks, it is essential to briefly explain the inverse relationship between bond prices and interest rates, plus, the "crypto winter" which was characterised by failure of cryptocurrency firms. It is these two phenomena, which were at the core of the recent banking crisis.

When interest rates rise, holders of previously purchased bonds with lower interest rates will see a decline in the market value of their securities, in the case that they may want to trade them for cash.

An example may be sufficient to explain this scenario. Suppose an investor purchases a 10-year bond at US$1000, with a 2% yield. That investor will get 2% yearly payments, culminating into US$20 per year, which is also US$200 over the next 10 years.

At the end of the 10 years, the US$1000 invested initially, will also be repaid. In the case that regulators or the central bank raise interest rates to 3%, anyone seeking to purchase a US$1000 bond will require at least a 3% return per year, which is US$30 in nominal value.

If the holder of the bond with 2% yield is in need of cash, and intends to sell the US$1000 bond for fundraising, its selling price has to be lowered below US$1000, so that it can at least have a 3% yield and become competitive in the market.

This is the same development that caused most of the fallen banks to collapse. They had invested heavily in long-term bonds with low yields, during periods of low interest rates, such as the year 2020, when interest rates were below 1%.

However, from 2021 to 2023, interest rates began to rise until, the current 5,25% mark, leaving the yields of previously bought bonds to be unattractive in the market. When there were bank runs owing to plummeting cryptocurrency prices, the banks ended up selling their long-term bonds at a loss so that they could meet the deposit requests of customers.

Cryptocurrency had an impressive hike in prices, particularly from 2020 to 2021. This was spurred by low interest rates that were being offered by US banks, at the time. Approximately, one in five Americans was using cryptocurrency and more US dollar investments were being channelled into crypto.

Nevertheless, from early 2022, changes began to occur, which led to a tapering down of demand and subsequently a collapse in crypto prices. Due to incoming inflation, the Federal Reserve started to increase interest rates, which served as a competitor to crypto investments and limited the availability of funds, which were previously directed towards cryptocurrency.

Due to lack of regulation of the crypto market, it also became apparent that some prominent firms in the sector were outright fraudulent companies.

These developments caused a plunge in demand and prices of cryptocurrency, including for those firms, which were operating with integrity. Banks that were heavily involved with cryptocurrency companies were not spared from the meltdown.

Silvergate Bank was California-based and provided much of its lending and deposit-taking services to businesses in the cryptocurrency market. At one time, more than 50% of its deposits were from Sam Bankman-Fried's entities, such as FTX.

Due to its specialised services to the crypto market, by Q4 2022, around 90% of its deposits were cryptocurrency-related. Apart from lending to the crypto market, the bank's assets were also assigned to long-term assets such as US Treasury bonds and mortgage-backed securities.

Trouble initially emerged when cryptocurrency firms were losing their value, during “crypto winter”, whilst some, such as FTX, were proven to be fraudulent.

There was a resultant run on the bank,which saw requests of daily withdrawals reaching US$8 billion, at one time. On 8 March, the institution eventually communicated that it would wind-down its business and liquidate in order to meet all its obligations to depositors and other creditors.

Silicon Valley Bank was based in California and at its peak was the 16th largest banking corporation in the US. It served mostly technology companies and wealthy clients with deposits exceeding US$250 000 per account.

This is noteworthy because such deposits do not get a reimbursement beyond the US$250 000 from the Federal Deposit Insurance Corporation (FDIC), in the case of a bank collapse.

It also served more than half of venture-capital-backed health and technology companies.When the Federal Reserve began to raise interest rates, clients of the bank had to use their cash deposited at the bank instead of expensive credit.

As concerns over the massive withdrawals grew, customers with deposits exceeding US$250 000 also began to pull out their funds, as they were concerned that the FDIC would not provide insurance for their excess funds.

This led to a thorough bank run until SVB had to sell some of its Treasury bondsto meet deposit requests. Their share price also plunged and on March 10, the bank was taken over by the FDIC and ultimately sold to First Citizens BancShares, just over two weeks later. Signature bank was focused on serving clients in New York City at the time of its demise. In a similar situation to Silvergate bank, the institution was highly invested in the property and cryptocurrency business.

At the beginning of this year, the bank became the second largest provider of banking services to the cryptocurrency industry, second only to Silvergate bank. As cryptocurrency prices began to tumble, in 2022, the bank had huge deposit withdrawals.

On March 12, due to the bank runs, and a sharp decline in its share price on the stock market, Signature bank was closed by regulators and sold to New York Community Bank, seven days later.

As the month of March was tumultuous, April was pursued with more news of imminent bank collapses. On April 28, First Republic Bank, another prominent regional bank, was taken over by the authorities (FDIC) and sold to JP Morgan Chase by May 1.

The bank also provided services to wealthy clients, who had deposits beyond US$250 000. This invoked deposit-withdrawal stress as depositors were concerned that any amount above US$250 000 would not be insured by the FDIC.

It had been under scrutiny since early March and its stock prices also plummeted sharply, towards its demise.

There are yet more banks, which are closely being watched, as their financial health is precarious. These are PacWest Bancorp, Western Alliance Bancorporation, First Horizon, etc.

In response to the crisis, the Federal Reserve introduced several pertinent programmes. The first was the Bank Term Funding Programme (BTFP), which provides loans to banks in distress, in exchange for high quality assets, such as Treasury bonds and mortgage-backed securities.

The BTFP aims to prevent banks from selling bonds at a loss as they try to meet massive withdrawal requirements. Loans were also made available, with less-stringent requirements, through the discount window, via which banks have traditionally been borrowing.

A record US$153 billion has been borrowed by banks through this facility, as of April 2023. Investigations into the conduct and transactions of collapsed banks have been launched in order to evaluate whether they were breaching banking ethics.

The "tailoring rules", which had been prescribed to reduce oversight of the Federal Reserve over small banks have also been revoked, and adjusted, in some parts.

Outstanding threats still await the banking sector, especially in the form of an impending US debt default, owing to the impasse in Congress regarding the raising of the Treasury debt ceiling.

If the US defaults, interest rates will go higher-up and this might mark the beginning of a fully-fledged domestic banking crisis.

It is fair to argue that the worst of this crisis has not yet been registered, unless the debt ceiling impasse is resolved.

Tutani is a political economy analyst. — [email protected]

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