By John Manning, International Banker
On May 1, US regulators confirmed the seizure of First Republic Bank (FRB), with the sale of the bulk of its assets to JPMorgan Chase having been promptly agreed upon. First Republic Bank, the 14th largest US bank with $229 billion in total assets and $104 billion in total deposits, was a San Francisco-based commercial lender with a largely affluent client base; it reportedly served those clients freshly baked cookies during branch visits. It was also the third American lender to collapse in quick succession. And with the ensuing panic even spreading to Europe and claiming Credit Suisse as a casualty, many now fear that a full-blown 2008-style global banking crisis looms. But is that really the case?
FRB’s collapse came not long after the failures of California-based tech-friendly lender Silicon Valley Bank (SVB) on March 10 and New York real-estate and crypto-sector lender Signature Bank a couple of days later. And just as the world awoke to the possibility of a major US banking crisis taking hold, the theatre for the industry’s failures soon shifted to Europe, where unstoppable client outflows left Credit Suisse teetering on the verge of collapse before regulators stepped in to broker a merger with its bigger Swiss rival, UBS, on March 19. The spotlight moved back across the pond in early May when First Republic Bank was shuttered and swiftly sold to JPMorgan Chase.
As such, those that endured the tumultuous events of 2008 might be forgiven for feeling a distinct sense of déjà vu, with a trickle of bank collapses similarly emerging back then at the beginning of the year. And while that trickle soon became a gallop, claiming the likes of Bear Stearns, IndyMac Bank, Lehman Brothers (which regulators memorably allowed to fail) and Washington Mutual (which, like FRB, was sold to JPMorgan Chase), the question on everyone’s mind today is whether a further deterioration in the banking system will transpire this year that, likewise, claims dozens of bank victims.
Or even more unthinkable: Could things be even worse this time around? Already, there is much concern over the sheer size of the banks that are going under. As it currently stands, FRB, SVB and Signature Bank are, respectively, the second, third and fourth largest bank failures in US history, with Washington Mutual still topping the charts. And at $532 billion, the three failed US banks of 2023 (so far) had more combined assets than the $526 billion (adjusted for inflation) in total held by the 25 banks that collapsed in 2008. With more major lenders, such as PacWest Bancorp and Western Alliance Bancorporation, exhibiting considerable fragility, that gap is set to widen dramatically.
But does that necessarily mean that history is repeating itself and that a 2008-style meltdown is all but guaranteed? Not quite. For one, the root causes of the sector’s current woes appear, thus far, different from the ones that rocked the global banking system back then. SVB, for instance, was largely undone by mismanagement of its excessive interest-rate risk. Amidst an environment of ample liquidity—with customer deposits far exceeding demand for loans—the last few years saw SVB amass vast amounts of ostensibly low-risk, long-dated debt securities, such as US Treasurys and government-backed mortgage securities. But the tech-centric lender was caught short once the aggressive monetary-tightening cycle unfolded last year, as sharply rising interest rates meant that the incoming fixed-interest payments on the bank’s longer-dated debt increasingly failed to offset the rising outgoing payments required on shorter-term deposits.
At the same time, the values of the bonds it held plummeted in the face of sharply rising bond yields, leading to more than $17 billion in losses for the bank’s portfolio by the end of 2022. Once clients got wind of the bank’s precarious position, it was inundated with around $42 billion worth of deposit-withdrawal requests, which the bank was unable to cover sufficiently. As such, regulators intervened to close the bank.
Although holdings of mortgage-backed securities contributed indirectly to SVB’s fate, therefore, it was not the quality of those assets per se that was chiefly responsible, but rather the interest-rate risk that arose from the mismanagement of the bank’s portfolio. In contrast, it was largely the toxic nature of the subprime mortgage debt held across the banking sector in 2007-08 that was crucial in the drying up of interbank lending at the time, as banks feared they would be caught with this debt on their books as collateral in any loan-issuance activity. And despite the U.S. Federal Reserve (the Fed) lowering interest rates considerably in the hope that it would fuel a resurgence of banking liquidity and confidence, dozens of lenders exposed to this bad debt soon faced the dire situation of having no one willing to provide them with credit, and they subsequently failed.
As such, perhaps the most significant distinction between the respective crises of 2008 and 2023 is that today’s banking system—largely through the harsh lessons learned from the Global Financial Crisis (GFC)—is significantly more resilient than it was back then. With a much more stringent regulatory framework governing banks now in place and with regulators themselves more aware of—and more responsive to—what is required amidst a deteriorating operating environment, many see this resilience as being fundamental in preventing a global crisis in the same mould as 2008 from materialising.
This responsiveness can be observed in the decision by the Federal Deposit Insurance Corporation (FDIC) to cover all of SVB’s deposits, despite normally guaranteeing only deposits worth up to $250,000 per customer, to protect SVB’s clients as well as avert potential contagion risks and allay growing fears amongst other banks’ customers that their own deposits were at risk. With the composition of SVB’s hugely wealthy client base meaning that an estimated 94 percent of the bank’s deposits—and around two-thirds of FRB’s deposits—were uninsured, this was a crucial decision for the government to take. The Federal Reserve also stepped in to provide liquidity to the troubled lenders in exchange for sufficient collateral, which further helped quell any immediate threat of a massive bank run.
But such actions can only alleviate the pain so much, truth be told. Much like in 2008, blame for this ongoing crisis has also been ascribed to the banks’ internal management. In its April 28 post-mortem report of SVB, the Fed noted that the bank’s “senior leadership failed to manage basic interest rate and liquidity risk. Its board of directors failed to oversee senior leadership and hold them accountable”. It also found that the bank’s board of directors did not receive adequate information from management about the risks at the time and did not hold management accountable for effectively managing those risks.
And as was the case 15 years ago, regulators have not escaped criticism for their seemingly erroneous handling of this crisis. SVB’s failure “demonstrates that there are weaknesses in regulation and supervision that must be addressed”, according to comments in the Fed report from Vice Chair for Supervision Michael Barr. “Regulatory standards for SVB were too low, the supervision of SVB did not work with sufficient force and urgency, and contagion from the firm’s failure posed systemic consequences not contemplated by the Federal Reserve’s tailoring framework.”
And while one can support the decision taken by authorities for equity investors to be wiped out in the rescue of SVB, one might reasonably question why Swiss regulators decided to eliminate top-tier (AT1) bondholders in the rescue deal for Credit Suisse, while lower-tier equity investors were inexplicably compensated to the tune of $3.23 billion. The secretive nature of the deal, which granted investors no input and used substantial taxpayer money, also warrants considerable scrutiny.
Even Warren Buffett recently acknowledged that regulators deserve their portion of the blame for the choices made by the failed banks. “The incentives in bank regulation are so messed up, and so many people have an interest in having them messed up…it’s totally crazy,” Buffett said at the annual shareholder meeting of his investment firm, Berkshire Hathaway. “If you look at First Republic, you can see that they were offering non-government guaranteed mortgages at fixed rates for jumbo amounts—that’s a crazy proposition to the advantage of the bank. It was in plain sight, and we all ignored it until it blew up.”
But at the risk of making excessive “like-for-like” comparisons between 2008 and 2023, it is also important to acknowledge the differences in the respective operating environments for banks during both crises. Indeed, the Fed’s SVB analysis also highlighted key factors distinctly of this day and age that proved hugely influential in expediting SVB’s demise and were either absent or non-existent 15 years ago—namely, the spread of information through social media, a highly networked and concentrated depositor base, and the use of technology. “Social media enabled depositors to instantly spread concerns about a bank run, and technology enabled immediate withdrawals of funding,” Michael Barr explained.
And given the “Silicon Valley-centric” nature of SVB’s business model, the technology sector itself inadvertently played a significant role in the bank’s collapse, especially in the wake of an unprecedented, decade-long bull run for the industry that saw funding liberally dispensed to a generation of cash-hungry start-ups before experiencing a sharp downturn amid last year’s global economic slowdown. This starkly contrasts the 2008 banking meltdown, in which the technology sector was not considered a key contributing factor.
“It’s no coincidence the runs started in California, among banks that were highly exposed to the tech sector—and which also, some add, favoured a risk-taking ‘move-fast-and-break-things’ approach to banking that led to plenty of innovation but ultimately broke the banks themselves,” John Rapley, a political economist at the University of Cambridge and managing director of economic research firm Seaford Macro, explained in the Canadian news publication the Globe and Mail. “In the cheap-money days, they were happy to borrow for next to nothing and invest in speculative ventures, some of which promised big returns. But when interest rates shot up, this business model went awry, making a shakeup inevitable.”
And as of now, this “shakeup” looks far from over. Key signs point to continued elevated stress levels within the banking sector that have raised serious concerns over its prospects this year. A glance at the Fed’s recent lending activity, for example, shows that its emergency lending to banks rose to $92.4 billion in the week ended May 10 from $81.1 billion the previous week, despite the rescue of First Republic. Bank borrowing from the Fed’s traditional backstop lending program, known as the discount window, also rose to $9.3 billion from $5.3 billion during the same period, while the Fed’s emergency Bank Term Funding Program (BTFP), which was specifically created in mid-March following the collapses of SVB and Signature Bank, saw bank loans reach $83.1 billion, up from $75.8 billion.
The Fed’s quarterly “Senior Loan Officer Opinion Survey on Bank Lending Practices” (SLOOS) published on May 8 also showed that banks had tightened their lending standards under the weight of the sector’s mounting turmoil. As such, loans will be harder for households and businesses to come by in the United States. “Perhaps what [this SLOOS report points] toward…is it shows that there is some evidence that banks are experiencing stress,” Jill Cetina, associate managing director of Moody’s Investors Service, told CNN on May 8. “I think we knew that before the survey, but now we have that quantified here with how it’s impacting lending.”
Clearly, none of this is particularly reassuring. While the Fed insists that the banking system is “sound and resilient, with strong capital and liquidity” and described SVB as “an outlier” due to its highly concentrated business model, interest-rate risk and high level of reliance on uninsured deposits, the continued concerning behaviours of lenders suggests that further fatalities from this crisis are just around the corner.
“Contagion may spread across a hyper-connected financial system from country to country and from smaller to larger, more systematically important banks,” Satyajit Das, noted former banker, consultant and author of numerous books on banking and finance, wrote in a March 23 article for the New Indian Express. “Declining share prices and credit ratings downgrades combined with a slowdown in inter-bank transactions, as credit risk managers become increasingly cautious, will transmit stress across global markets. For the moment, whether the third banking crisis in two decades remains contained is a matter of faith and belief.”