The US government also agreed to indemnify depositors at SVB for all their personal deposits, though the American Treasury normally only guarantees sums up to $250,000. Meanwhile in staid Switzerland, home of the numbered bank account, the government had to broker the rescue of the country’s second biggest bank, Credit Suisse. Yes folks, we are in the middle of yet another banking crash. Hold on to your money.
Of course, all this is both predictable and strangely normal. Banks may make the (economic) world go round but they are magnificently unstable beasts at the best of times. Banks take in deposits (or borrow from each other) on the promise to return the cash more or less on demand.
They then lend this money long term, meaning they can’t get it back again quickly. If all or most of the depositors get a fright and suddenly want their savings back, it is curtains for the bank. And, sadly, for the depositors because their money goes up in smoke unless a friendly government uses taxpayers’ cash to bail them out.
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Being unstable creatures, banks fail with regular monotony – usually we have a significant banking crisis every decade. The last big one was 15 years ago, so the latest financial wobble is actually a bit behind schedule. Again, the norm is that banking crises follow in the wake of economic booms, as the latter encourage reckless lending by greedy bankers. Post-Covid, we are in the midst of an inflationary boomlet. Hey presto, banks now are falling down like grenadier guardsmen on a sunny day trooping the colour ceremony.
But didn’t global leaders and central banks put in place new, tougher regulation of the big banks, after the 2008 crash? Yes, they did. The biggest banks – those deemed too big to fail, lest they brought down the global economy – were forced to keep big capital reserves against a rainy day. Threats were also made to make senior bankers personally liable for bad lending decisions (aka insane gambling with depositors’ money) but most governments, including in the UK, backed off from that dangerous precedent.
Just in case, bankers moved to protect their personal interests by entering government. Rishi Sunak is a former investment banker, as is President Macron.
So why did the latest round of bank regulation fail? The answer is: it always does. The newly regulated part of the banking system will carry extra compliance costs and so make less profits (recently compounded by low interest rates). This ensures that footloose capital migrates to the unregulated – or less regulated – part of the system, where profits are obviously higher.
For instance, SVB was outside the main US regulatory rules that applied to bigger banks. It was therefore able to attract millionaire and billionaire depositors. When Covid lockdowns boosted sales in household high tech, SVB found itself drowning in new customer deposits by tech companies.
The laidback SVB management then invested this cornucopia in daft ways, while neglecting to insure themselves against a rise in interest rates (so-called “hedging”). Interest rates duly went up and SVB collapsed.
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As a rule, financial crises always begin in the less regulated part of the system. What we are seeing now is a classic wobble precisely in the less regulated sector. It began last year in the UK when Liz Truss & Co embarked too quickly on a plan to boost public spending, paid for by government borrowing. Nothing wrong with that in theory except she frightened the horses, ie institutions who lend to government. They wanted higher interest rates, so the cost of UK state debt went through the roof.
Unfortunately, higher rates on new bonds crashed the value of existing government bonds. Big pension funds who hold existing bonds were instantly in trouble. Unlike SVB, the UK pension funds had hedged their investments. But they had been inveigled into doing this in a new-fangled kind of insurance policy – so-called liability driven investment – essentially gambling in the unregulated bit of the system using complex financial derivatives provided by banks and hedge funds.
But this wheeze was destined to fall apart if everyone tried to claim at once, which they did. Last September the British pension funds faced immediate collapse, taking your private pension with them. The Bank of England had to arrange a bailout, worth £65bn of new money.
How bad is the fire, this time round? So far, the financial contagion has engulfed smaller banks (eg SVB) and the wobbliest bigger banks (eg Credit Suisse). But the usual pack of stock market ghouls have started selling off shares in banks suspected of weak management or low profitability. Hence the share value of Deutsche Bank nosedived by 14% on Friday. Meanwhile, central banks in the US and UK have had to raise interest rates again, in a bid to curb inflation. But higher rates risk triggering a recession. And a recession could be the straw that breaks the weaker banks, as mortgage holders start to default on their bank loans. Oops!
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This latest financial crisis would have exploded like a political timebomb had Scotland now been headed for an October independence referendum. The SNP plan to keep using the British pound pro tem in the middle of a banking and pension melt-down would have raised unsolvable questions for the SNP leaders to answer. But keeping sterling was meant to shut down awkward questions.
Yet how could an indy Scotland without its own currency or central bank have rescued the big pension funds, some of which are Scottish based? It couldn’t. How could Scotland without a central bank protect customer deposits, if there was an SVB-style run on a local bank? It couldn’t. How could an independent Scotland ensure better bank regulation without a regulator? It couldn’t.
Here is my solution. The incoming SNP leader and FM has to reverse the mind-blowingly stupid idea that an independent Scotland can avoid taking steps to create its own regulated banking system and currency from day one. Which means we need to start today to create the blueprint for a local financial system. We must move beyond the good work done by Tim Rideout and the Scottish Currency Group, and see the Scottish Government set up an official Monetary Institute. This would provide advice on monetary policy and financial regulation.
We can’t wait until independence to set up our financial architecture.
But can banks ever be regulated effectively? There are solutions. After indy, mortgage lending should be restricted to mutual building societies, as of old. Retail banks should be restricted to the ordinary loan business and banned outright from speculation in risky assets. State investment banks should lend to industry and business, prioritising growth sectors and net-zero activities. We need a mutual savings sector to encourage personal saving, keeping local deposits circulating in the local economy. None of this will make super profits. But it is the hunt for get-rich-quick, high returns that lies at the heart of our maverick banking system.
That we can do without.