Global banking has been in turmoil over the last two weeks following a series of stunning bank collapses in Europe and the United States.
Despite a series of rescue packages for troubled lenders and the assurances of governments and financial regulators, concerns about the health of the global financial system persist in the aftermath of the March 10 collapse of Silicon Valley Bank (SVB).
Even as economists caution against comparisons to the bank failures that precipitated the 2007–08 financial crisis, investors are skittish amid speculation that other financial institutions could soon land in trouble.
What is behind the ongoing turmoil in the banking sector?
While US regulators hoped to shore up confidence by guaranteeing deposits at SVB and crypto-focused Signature Bank earlier this month, the collapse of Credit Suisse over the weekend reignited fears of contagion across the financial sector.
Unlike SVB, a mid-tier bank, Credit Suisse is a financial behemoth – big enough that it is among 30 banks considered to be of systemic importance to the global economy.
The Zurich-based bank held about $1.1 trillion in assets in 2021, according to S&P Global, making it the 45th largest lender in the world. By comparison, SVB, the 16th-largest bank in the US, had about $209bn in assets last year.
Although Credit Suisse has been dogged by concerns over its financial health for years following a raft of scandals, the bank’s sale to UBS on Sunday delivered a blow to Switzerland’s image as a haven of financial stability and sparked volatility in financial markets.
While some bank stocks rose on news of the deal on Monday, big lenders, including HSBC and Standard Chartered, saw their share prices fall. On Tuesday, Asian stocks regained some ground in a sign of easing jitters, with the MSCI’s broadest index of Asia-Pacific shares outside Japan rising 0.4 percent.
First Republic, one of a number of regional US banks under pressure in recent days, saw its share price plunge nearly 50 percent amid fears the San Francisco-based lender could need a second bailout only days after receiving a $30bn lifeline from top US banks, including JPMorgan Chase, Bank of America and Wells Fargo.
Despite being intended to quell market panic, the nature of Credit Suisse’s takeover has also stirred unease.
Under the rescue plan, Swiss authorities marked the value of 16 billion Swiss francs ($17bn) of bonds down to zero, while letting shareholders keep about 3 billion francs ($3.2bn) of their investment.
That decision upended the longstanding norm in debt recovery that shareholders, not bondholders, should suffer the biggest losses – outraging those who lost all of their investments.
Some bondholders have argued the move goes against the law and raised the threat of legal action.
Iris Chiu, a professor of corporate law and financial regulation at University College London, said banks may be more vulnerable to “information contagion” and market panic following post-2008 reforms that put shareholders on the hook for losses in order to spare taxpayers.
“This means if a weak link is exposed, investors become paranoid about sniffing out other weak links in order to sell down assets or pull liabilities,” Chiu told Al Jazeera.
“I think a large part of that has to do with the increase in ‘bail-inable’ debt that banks have issued to make their capital positions stronger – these place shareholders and creditors on the hook first before state bailout, and can make investors more sensitive during times of uncertainty. Bail in may unfortunately also exacerbate bank crisis perceptions and then leads to self-fulfilling prophecies regarding bank crisis.”
The merger of Credit Suisse with UBS, Switzerland’s biggest bank, has also raised concerns about the proliferation of more institutions deemed “too big to fail”.
Thorsten Beck, director of the Florence School of Banking and Finance, described the takeover as a “terrible idea, creating an even bigger too-big-to-fail institution”.
“But it shows again that all the talk about bail-in before the crisis is quickly forgotten when things turn south,” Beck told Al Jazeera.
What can be done to stem the panic?
After several bank rescues already, there are indications that authorities are planning further actions to shore up confidence.
In the US, financial regulators are considering temporarily guaranteeing all bank deposits, which are currently protected up to only $250,000, Bloomberg News reported on Monday.
Regulators announced similar moves to guarantee all deposits at SVB and Signature after those lenders got into difficulty earlier this month.
Extending protections to all deposits would raise questions about moral hazard, the situation where an investor or depositor has an incentive to take greater risks due to the knowledge he or she will not suffer any losses.
“I do think SVB is going to force a rethinking of the regulatory framework. The treatment of uninsured deposits is obviously a significant part of the problem,” David Skeel, a professor of corporate law at the University of Pennsylvania Law School, told Al Jazeera.
“They’re legally at risk, but banking regulators nearly always bail them out, dating back to the 1984 failure of Continental Illinois. This situation reminds me of the ‘constructive ambiguity’ as to whether big banks would be bailed out back in 2008, which proved to be disastrous. Expectation but no certainty of a bailout often works out badly. It seems to me that regulators need to develop clear guidelines as to which depositors will and won’t be protected.”
In the longer term, Democrats, including US President Joe Biden, have flagged the need to tighten the oversight of banks, including restoring key provisions of Dodd-Frank reforms that were rolled back under the administration of former President Donald Trump.
Among the changes being sought by Democrats, who would likely face resistance from Republicans, is the restoration of the $50bn threshold for “too big to fail” banks subject to stress tests designed to assess their ability to weather a serious economic downturn.
Could we be heading for a meltdown of the global banking system?
Most economists see that as unlikely, although turmoil at more financial institutions is possible.
Not only have authorities moved swiftly to contain the fallout, financial regulation has also been tightened significantly since the last global financial crisis.
Compared with 2007-08, for example, banks are required to have much more capital on hand to deal with a severe downturn.
“The global banking system is not about to collapse,” Beck said. “What we see: with the tide receding, we see who has been swimming naked. Credit Suisse is not a surprise – given previous trouble – as are several of the mid-sized banks in the US. Could some other European banks be affected? Yes, possibly, but this would not be the same as a collapse. Overall, the banking system is significantly stronger than it was in 2008 and authorities are much better prepared to address distress early on.”
“The fallout from the SVB failure has been more sustained and widespread than I expected,” Skeel said. “I anticipated that it would blow over quickly given the idiosyncrasies of SVB, and that obviously hasn’t been the case. But I still don’t think it’s likely to spur a major banking crisis.”