In last week’s edition of Three Longs & Shorts, we had highlighted a blog by Marc Rubinstein in which we had explained that what is unique in the latest wave of bank runs in America is that depositors no longer have to queue up to get their money back and that makes the banking system more fragile now than it was ever before: “Prior to 2022, there had only been 10 quarters of deposit outflows in the US in the past fifty years; we’ve now seen four quarters of outflows. But the factors that led to Silicon Valley Bank gaining deposit share on the way up are instrumental in it losing share on the way down.
…We’ve never really had a bank run in the digital age. Northern Rock in the UK in 2007 predated mobile banking; it is remembered via images of depositors lining up (patiently) outside its suburban branches. In 2019, a false rumour on WhatsApp started a small run on Metro Bank, also in the UK, but it was localised and quickly resolved. Credit Suisse lost 37% of its deposits in a single quarter at the end of last year as concerns mounted about its financial position although, at least internationally, high net worth withdrawals would have had to have been phoned in rather than executed via an app.
…The issue, of course, is that it is quicker and more efficient to process a withdrawal online than via a branch. And although the image of a run may be different, it is no less visible. Yesterday, Twitter was alight with stories of venture capital firms instructing portfolio companies to move their funds out of Silicon Valley Bank. People posted screenshots of Silicon Valley Bank’s website struggling to keep up with user demand.” (Source: https://www.netinterest.co/p/
This week in the Washington Post, Sebastian Mallaby, who is an acknowledged expert on the US banking system, explains why from a fundamental (i.e. financial accounting) point of view, America’s banking system is in a difficult place: “Consider two numbers. Total capital buffer in the U.S. banking system: $2.2 trillion. Total unrealized losses in the system, as calculated in a pair of recent academic papers: between $1.7 trillion and $2 trillion.
In other words, if banks were suddenly forced to liquidate their bond and loan portfolios, the losses would erase between 77 percent and 91 percent of their combined capital cushion. It follows that large numbers of banks are terrifyingly fragile.
This is, shockingly, a surprise. Until the failure of Silicon Valley Bank on March 10, nearly everyone supposed that U.S. banks were comfortably capitalized. Investors knew full well that the Fed’s interest rate hikes, a necessary but belated response to inflation, had clobbered the bond market. They also knew that banks own a lot of bonds. But the potential scale of the banks’ unrealized losses — the difference between what they originally paid for their bonds and what they now could sell them for — generally escaped remark.”
This observation from Mr Mallaby has several implications. Let’s take them in sequential order and then join them up to understand the magnitude of what is playing out. Firstly, as has been noted by several other experts, the general quality of prudential regulation in the USA seems to be poor. SVB was not a particularly complicated bank and yet it blew up. Furthermore other banks like SVB seem to be in trouble – see
https://apnews.com/article/
Secondly, the SVB rescue (and the Credit Suisse rescue in Europe) further ramps up the moral hazard that the GFC had created. During the GFC, only the big institutions were rescued with public money. Now it seems that even midsized lenders will be rescued with public money. This creates a new paradigm called ‘capitalism without risk’ – see this piece by George Will to understand some of the consequences of this:
https://www.washingtonpost.
In a way, the first and second points are related – the weaker a regulator’s risk monitoring & risk management abilities, the more prone that regulator is to sponsoring bail outs, the greater the moral hazard embedded in capitalism, the greater the chances of another round of blowups a decade hence.
Thirdly, and perhaps most importantly for us in India, with the Western banking system resting on fragile foundations, de facto, if not de jure, monetary easing is all but assured. Western politicians face skewed incentives now – if they hike rates further and inflation still persists (as it is most likely will given that is being fuelled by supply side factors such as the ageing of the West, the removal of China from global supply chains, etc) AND the banking system continues to implode with rising losses on bond & loan portfolios. On the other hand, if they don’t hike and quietly flood the system with backstops and liquidity, they will live to fight another day.
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