In the past month, news from the banking sector on both sides of the Atlantic has caused minor fluctuations in financial markets. Firstly, it should be noted that this fluctuation does not represent a systematic crisis affecting the entire banking sector but rather is limited to a few individual banks. Secondly, the increase in interest rates and tightening of liquidity conditions are not its root cause.
Silicon Valley Bank, the first bank where the crisis began, is a boutique bank serving technology companies and specialized venture capital firms with very high growth rates. Considering that the average deposit size for all of America is $41,600, it can be understood how much higher the deposit sizes of the bank's clients are, which is $4.2 million. Similarly, Signature Bank provides specialized banking services to individuals and companies in digital currency and real estate sectors. Like all other banks, both have invested these deposits in loans, long-term government bonds, and mortgage-backed securities.
Starting from mid-2022, rising inflation has caused a change in global interest rate policies. Central banks have entered a contractionary monetary policy by increasing interest rates and selling securities. The rising interest rates and tightening liquidity have led some young technology companies to begin using the deposits they had placed for their operational and investment needs by withdrawing them. To provide cash for the outflow of deposits, SVB officials decided to sell long-term bonds at a high rate. The resulting loss from the bond sale has disrupted the bank's liquidity and capital ratios. When the bank wanted to increase its capital to correct this situation, its stocks lost their value rapidly, accelerating the outflow of deposits. The concerns at SVB have caused the customers' problems about the other two banks to increase and their deposits to be withdrawn. On the same day, SVB was taken over by regulatory agencies due to severe disruptions in its liquidity and capital ratios, followed by Signature Bank. However, the deposits of depositors were guaranteed without a limit. Another bank, First Republic Bank, facing similar problems, was rescued with the support of five central banks in the sector depositing $30 billion in deposits.
At this point, one of the banks' mistakes in risk management is investing in long-term bonds instead of short-term government bonds, considering their deposit compositions and liquidity problems. Short-term bonds' price changes are less than long-term bonds when interest rates change. However, regulatory authorities did not see this risk because banks with a size below $250 billion (approximately 12-13 banks) were kept outside of the Fed's supervision during the Trump era. As before, the Biden administration is expected to remove this limit and require all banks to be subject to Fed supervision. The mistake of policymakers is that they should have considered the possibility of such a risk. In fact, in October 2022, the proposal for a tax rate by the short-term Prime Minister of the United Kingdom, Liz Truss, resulted in a rapid and uncontrolled rise in interest rates, causing pension funds to become insolvent and subsequently being rescued by the Bank of England's intervention. This experience should have been an essential signal for policymakers and regulatory authorities in America and Europe, but these institutions needed to understand it.
The total assets of the two banks facing bankruptcy are less than 0.05% of the banking sector's total assets. Therefore, the crisis is not a threat to the system. The risk of spreading to other American banks is relatively low if policymakers do not limit insurance coverage to $250,000 for a while and the Fed re-audits all banks. However, this fluctuation will cause the Fed's interest rate increase process to end at lower rates.
The turmoil in America also caused problems for Credit Suisse, one of Switzerland's most critical European banking countries. Unlike the troubled banks in America, the bank operates globally with clients with high-volume deposits, primarily through its wealth management unit. The announcement by the bank's largest shareholder, the National Bank of Saudi Arabia, that they will not provide capital support if necessary caused high-deposit customers to withdraw their deposits. The mistakes made by the bank in management and risk management over the past decade have caused a severe trust problem. As a result of the rapid deposit outflow, the bank experienced a liquidity crisis and was sold to its rival, UBS, at a meager price. In the past decade, legal authorities have fined significant amounts of credit to Suisse for crimes such as providing banking services to illegal individuals and money laundering, which can be cited as management mistakes. The $5.5 billion loss incurred by the collapse of the Archegos fund is an example of risk management mistakes.
