There has been a lot of talk about the risk of financial contagion following the collapse of California’s Silicon Valley Bank.
Perhaps too much talk.
While the frequency of bank runs in the past shows the power of emotions to move markets, there’s little reason to panic.
We’re not looking at anything like the circumstances that precipitated the global financial crisis of 2008.
If you’ve got your savings in any bank or credit union in Australia or New Zealand, the greatest fear is fear itself.
Just two other US banks, the New York-based Signature Bank and First Republic in San Francisco, have been caught up in the trouble.
Internationally, the only casualty is Credit Suisse in Switzerland, whose customers have been saved by loans offered by Switzerland’s central bank and takeover by Switzerland’s largest bank, UBS.
It is likely that until a few weeks ago you’d never heard of Silicon Valley Bank (or Signature or First Republic).
But Credit Suisse, founded in 1856, is known around the world.
It was regarded as one of the 30 systemically important global banks.
What do its troubles have to do with Silicon Valley Bank?
Not much, except that fear is contagious, and the bank already had problems that made it extra susceptible to panic.
Apart from fear, the one common factor in these bank failures is the impact of higher interest rates on government bonds.
Bonds are a form of debt.
Governments issue them to raise money in excess of their tax revenue.
Bond buyers are paid regular fixed interest (known as a “coupon”) until the bond matures when the issuer repays what the original buyer paid for the bond.
Banks like bonds, particularly in uncertain times.
Even though they pay less interest than on other forms of debt, there’s an extremely low risk of default.
Governments rarely go broke.
They can always raise funds through taxation, or issuing more bonds, to meet their obligations.
In the early months of COVID, as central banks slashed interest rates as much as possible to sustain economic activity, the already low rate of interest that governments paid on bonds dropped further.
In some cases, this meant bond yields were even negative.
But they were still attractive to banks because of the low default risk compared to, say, lending money to companies facing tough times.
But then came 2022 and unexpected inflation, as economies recovered and Russia’s war on Ukraine pushed up global energy prices.
In response, central banks began quickly pushing up interest rates.
Bond interest rates rose too.
The interest rate on a ten-year US treasury bond, for example, was about 1.5% in November 2021.
A year later it was more than 4%.
These higher yields on new bonds have lowered the value of existing bonds that pay less interest.
Any bank wanting to sell those bonds (on a secondary market) must do so for less than what it paid.
This is what happened with Silicon Valley Bank.
The early stages of the pandemic were great for it.
Deposits by customers, concentrated in northern California’s high-tech industry, tripled.
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The bank then invested heavily in US government bonds, intending to hold them until they matured.
Then came inflation and the tech industry downturn, with many companies announcing layoffs.
Customers started drawing down their deposits to pay their bills.
To cover those withdrawals, the bank had to sell bonds at a loss.
This reduced market confidence in the bank, leading to further withdrawals by depositors worried it might collapse.
Fear of a collapse became a self-fulfilling prophecy.
But the outcome of a classic “bank run” – with fear spreading through an interconnected financial system – was prevented by the US Federal Reserve stepping in to guarantee deposits.
So what has this to do with Credit Suisse?
Like Silicon Valley Bank, which had poor risk controls, it too had specific problems indicative of poor management.
It has been implicated in providing banking services to corrupt and criminal clients.
In June 2022 it was convicted in Switzerland’s Federal Criminal Court for failing to prevent money laundering by cocaine traffickers.
In short, Credit Suisse was a disaster waiting for a catalyst.
The collapse of Silicon Valley Bank, and the talk of a global banking crisis, were enough to send already jittery customers to the exit.
Credit Suisse’s largest shareholder, Saudi National Bank, then bluntly and publicly refused to contribute more capital.
In my view, the chances of any bank in Australia and New Zealand following this trajectory are effectively zero.
There are a lot of crossovers between the two countries’ financial sectors and the principal banking regulators, the Australian Prudential Regulation Authority and the Reserve Bank of New Zealand.
To prevent bank runs from developing, the RBNZ and APRA set minimum levels of liquid assets that can be quickly converted to cash to cover withdrawals.
It is almost a century since any depositor in an Australian bank lost even a portion of their money.
This is not to say there haven’t been crises.
For example, in 1979 the Bank of Adelaide faced collapse.
The RBA organised massive loans from other banks.
It was then taken over by ANZ Bank.
Depositors kept their savings.
In 1990 the troubled State Bank of Victoria was taken over by the Commonwealth Bank of Australia (then still owned by the Commonwealth government).
Again, depositors didn’t lose.
In the very unlikely event, a bank did fail, Australian depositors are also protected by a federal government deposit insurance scheme called the Financial Claims Scheme.
This was set up during the global financial crisis to protect customers of banks, credit unions, building societies and general insurers.
It guarantees that every depositor with up to $250,000 will get their money.
The NZ government has a similar scheme in the works, with legislation expected to become law later in 2023.