The events over the past week bear an eerie resemblance to those of the 2008-9 Global Financial Crisis (GFC). Banks have failed, rumours swirl about the next victim and investors hold weekend vigils awaiting the next alphabet soup solution from banking authorities. So should we be concerned? Is there good reason to think that we are on the cusp of a major financial crisis, and should depositors fear the safety of their money?
The GFC sparked significant changes in the regulation of banks across developed markets to shore up the banking system and increase confidence. Banking regulation is an incredibly complex subject with differences across regions. However, the thrust of the regulation has delivered two key changes to banks over the past decade:
Therefore, depositors should be more confident that the banking system is safe from risks stemming from a deterioration in the quality of the banks assets. Banks liquidity situations are much improved and bank solvency is very unlikely to be an issue.
But the collapse of Silicon Valley Bank (SVB) highlights that despite these measures, banks can still fail. In fact, the collapse of SVB was partly because their assets were largely comprised of very high-quality assets in the form of US government bonds. Unfortunately, they had purchased these bonds over the past few years when interest rates were low and bond prices high. The bank had in effect bought long dated bonds and funded that with short dated deposits. When some of their depositors needed their money back, the bank was forced to sell some of these bond assets and realise a loss on their investment*. Is this a systemic problem and could other larger banks fail for the same reason? Again, there are reasons to think not:
After a major bank collapse, inevitably investors are on the alert for the next potential victim. Credit Suisse has had its fair share of travails over the past few years and so confidence in the bank was already low. But here too, authorities have been quick to act to ensure that the bank is not a victim of a liquidity crisis. The Swiss Central Bank has provided CHF50bn in loans to the bank to ensure that the banks depositors can be confident they can maintain access to their money.
All of this is to point out that the banking system as a whole is much more robust than a decade ago. Depositors should be much more confident that their money is safe in banks and the risk of another GFC is extremely low. In many respects, the SVB collapse has illustrated that the regulations and process to protect depositors have worked. All depositors in the failed banks were given access to their deposits on the Monday following the Friday collapse. But whilst depositors have not lost a cent, shareholders have borne the loss of their investment, illustrating that investments in banks still carries risks.
*It’s worth noting that if the depositors didn’t require their money bank and simply left them in the bank, the bank’s assets would have appreciated in value over time and the bank would have likely remained profitable. This was not an issue of profitability but one of risk of liquidity, i.e. deposit flight.
Disclaimer: Milford is an active manager with views and portfolio positions subject to change. This blog is intended to provide general information only. It does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to a Financial Adviser. Past performance is not a guarantee of future performance.