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  • Writer's pictureKarl Pichelmann

Devil takes the hindmost? A banking crisis déjà vu.

The Bureau conversation took up the current turmoil in the banking sector looking into the causes and origins of recent bank failures, and discussed possible implications for wider financial market instability and the overall economic outlook in general.

The lead speaker briefly reviewed the recent events starting with a stream of crypto-led bankruptcies that ultimately drove the demise of Signature Bank of New York. Two days earlier Silicon Valley Bank, a lender to start-ups and their venture capital backers, had collapsed after a digital depositor run. First Republic Bank received an industry-led emergency cash injection and linked up with Lazard and JP Morgan Chase on strategic options; Pacific Western Bank had to turn to investment firm Atlas SP Partner for a $1.4 bn financing facility. Tensions spilled over to Europe and claimed Credit Suisse - born in 1856 and killed, at least according to its Chairman, by a social media storm.

The lead speaker argued that the recent failures of regional banks in the US were outliers with problems unrelated to Credit Suisse, but safeguards to protect the banking sector after 2008 fell short, and while authorities responded promptly, regulators and financial analysts have lost a ton of credibility. In the US, in particular, the 2018 rollback of the Dodd-Frank act, the biggest deregulatory effort since the financial crisis, had raised the threshold for financial institutions to be considered systemically important from $50 bn in assets to $250bn, thereby allowing for blatant supervisory shortcomings. External control by market observers spectacularly failed to do its work as well with Silicon Valley Bank named to the Forbes magazine's inaugural Financial-All Stars list just weeks before its collapse.

Problems at Credit Suisse, Switzerland´s second-largest bank by assets, on the other hand, had brewed for years and were well-known, putting investors and deposit holders tightly on edge in an already tense atmosphere. Concerns about the bank´s viability reached a tipping point after ill-conceived comments by its largest shareholder, Saudi National Bank, that it was not considering adding to its investment due to regulatory rules. The announcement of tapping a more than $50 bn lifeline from the Swiss National could not quell the storm, and it quickly became clear that a rescue of the bank, considered as systemically important given its size and interconnectedness with the financial system, was required. In an arrangement hammered out under immense pressure over a weekend, Credit Suisse`s larger and long-time rival UBS Group agreed to buy it for 3 bn Swiss francs in an all-share deal. The Swiss government committed to backstop 9 bn francs of potential losses from Credit Suisse`s assets and allowed UBS to wipe out about $17 bn of Credit Suisse bonds. The decision to completely wipe out the AT1 bonds while preserving some value for shareholders has met some criticism, but according to the lead speaker it was "perfectly legal and exactly for their purpose."

Some market jitters have continued since then - with Deutsche Bank and some midsized US banks being mentioned in this context -, but by and large further widespread contagion could be avoided so far. Concluding, the lead speaker stressed again the role of regulatory capture/failure and doubted whether authorities would ever be in a position of pre-emptive resolution "before a bank actually falls over Seneca´s cliff". He pointed to the as yet untested resolution scheme in the euro area and regretted the lack of progress with respect to banking union, which in his view "if anything has gone into reverse."

Participants appreciated the lead presentation and broadly agreed with the main arguments brought forward. Views diverged whether the discussed events were a harbinger of much more serious troubles down the road. While most participants found a re-run of the 2007/2008 banking crisis rather unlikely, not least due to the healthier capitalisation of the banking system, a few others pointed to an inherent fundamental instability of the financial system in a period of high inflation with rapidly rising interest rates. There was broad agreement, though, that the recent stress in the banking sector has unequivocally complicated the mission of central banks to fight inflation; and it will probably put another drain on economic activity due to tighter lending standards and financial conditions. In the concluding words of the Chairman, "the risks of stagflation have further increased".

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