There’s an old saying about how the flap of a butterfly’s wing in one corner of the world can lead to a hurricane in another. This week’s events have shown precisely how these knock-on effects can be transmitted across the globe, with the closure of three relatively regional banks in the US leading to panic not just in the European banking sector, but also in Asian stock markets.
The genesis of this world-wide banking contagion was the collapse of Silicon Valley Bank last week, but there has been enough turmoil in the banking sector since even Monday to make the global banking sector our Newsmaker of the Week.
First, a bit of recent history before we get to the week that has just elapsed. Silicon Valley Bank (SVB) was a pretty integral part of the tech startup ecosystem in the US, since it not only lent to startups in need of funds for growth, but also held a large chunk of their deposits.
When problems became visible in the bank last Wednesday (8 March) due to a confluence of bad luck and poor financial planning, all the President’s horses and all the President’s men rushed to put Humpty Dumpty together again. Within a couple of days of the crisis breaking out, three different regulator institutions shut down the bank, secured its deposits, and promised depositors that they would have access to all of their deposits, not just the insured ones.
Unlike the nursery rhyme, Humpty Dumpty was put together again pretty quickly—to an extent. With the collapse of Silvergate Bank and Signature Bank that same week—and for pretty much the same reasons—deep cracks had been made in investors’ confidence in the banking sector.
That’s what leads us to this week.
Also read: Why Silicon Valley Bank, a tech startup darling, collapsed and how US govt saved depositors
Panic, from Europe to Asia
US President Joe Biden kicked off the week on Monday with a speech where he emphasised that “no losses will be borne by the taxpayers” due to the SVB crisis. Instead, he said, the money will come from the fees that banks pay into a Deposit Insurance Fund, maintained by the Federal Deposit Insurance Corporation (FDIC). Sounds good, but the jitters had hit and the US banking stocks were not going to be calmed so easily.
On Monday and Tuesday, the stocks of regional banks in the US and of the overall banking sector remained volatile. While some of them tried to mount a recovery, most remained well below their historical levels.
And what happens in the US doesn’t stay in the US. This contagion of panic quickly jumped oceans and hit European and Asian banking stocks hard. According to reports, European banking stocks suffered their biggest drops in a year on fears that what was happening in the US could spread, and could reveal previously hidden weaknesses in banks around the world.
India was not spared. The stock market on Monday fell sharply, led by a fall in banking stocks.
With banking stocks in Europe taking a hit, one of the worst-affected was Swiss banking major Credit Suisse. Now, Credit Suisse has had a tumultuous last couple of years, during which various senior bank officials have been implicated in several scandals, including a spying scandal in 2020, a cocaine-related money laundering scandal in 2022, and the management has changed a few times in response.
This is not counting the fact that its financials aren’t in great shape, with it having to pare back the bonuses it was giving its senior management after it reported its largest-ever loss since the Global Financial Crisis of 2008. In other words, things have been precarious at Credit Suisse for a while now, and the US banking crises were not helping matters.
However, what really pushed it off the brink was a statement made by Credit Suisse’s largest shareholder—Saudi National Bank—which said that it would not inject any more money into Credit Suisse. The already-fragile investors in banking stocks in Europe reacted to this statement with alarm. All banking stocks, led by Credit Suisse’s, fell sharply.
It was clear that Credit Suisse and the Swiss banking regulators would have to take some decisive action to settle these severely frayed nerves. On Wednesday, the Swiss Financial Market Supervisory Authority and the Swiss National Bank issued a statement aimed at doing just that.
“The Swiss Financial Market Supervisory Authority (FINMA) and the Swiss National Bank (SNB) assert that the problems of certain banks in the USA do not pose a direct risk of contagion for the Swiss financial markets,” the statement said.
It added that Credit Suisse meets the capital and liquidity requirements imposed on systemically important banks and that the SNB would provide Credit Suisse with liquidity if needed.
Turns out, it was needed.
With banking stocks still plummeting, and no real signs that investors were feeling less jittery, Credit Suisse on 15 March announced that it was indeed taking a loan from the country’s central bank.
“Credit Suisse is taking decisive action to pre-emptively strengthen its liquidity by intending to exercise its option to borrow from the Swiss National Bank (SNB) up to CHF 50 billion under a Covered Loan Facility as well as a short-term liquidity facility, which are fully collateralised by high quality assets,” Credit Suisse said in a release.
Finally, this seemed to have restored some confidence in the system, with the company’s stock price recovering substantially that day.
Also read: SVB fall shows it’s not just about credit risk. It’s also about the silent role of interest rate
There’s more to it
However, the drama was not done yet. Due to the rapid onslaught of this banking crisis, the European Central Bank (ECB) was facing a dilemma over whether to hike the interest rates, where it was damned if it did, and damned if it didn’t.
Raising interest rates would likely exacerbate the problems that had led to such a crisis in the first place. But not hiking them would be an admission that it was the ECB’s policies that led to the crisis, not to mention the fact that inflation would have risen again. It would also have given a signal that the crisis was actually quite serious.
As it happens, the ECB held its nerve and kept its focus on reducing inflation, hiking interest rates by 50 basis points, as it had earlier said it would do.
“Inflation is projected to remain too high for too long,” Christine Lagarde, president of the ECB, said. “Therefore, the Governing Council today decided to increase the three key ECB interest rates by 50 basis points, in line with our determination to ensure the timely return of inflation to our two per cent medium-term target.”
Friday looked a lot better after all of these steps and announcements, with European and US banking stocks rising once again, and the Indian Sensex and Nifty too ending 355 points and 139 points up.
Things are still fragile, and nerves in the banking sector are still frayed, but it looks like the immediate crisis has been stemmed. But next week is another story!
Views are personal.
(Edited by Prashant)