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In 2008, we experienced the virtual collapse of the global financial system, following the implosion of the US sub-prime mortgage market. This created a domino effect around the world, devastating many banking systems. When confidence in banking evaporates the risk of contagion is very real and very dangerous.

SVB (and the rest)

In March, Silicon Valley Bank (SVB) became the second largest in US history to collapse, and the biggest lender to fail since 2008.

SVB was heavily involved in technology start-ups. At the peak of the tech boom, SVB placed $91 billion in deposits in long-dated securities. Over the past year, the value of those bonds fell heavily, as the US Federal Reserve increased short-term interest rates. SVB's other assets were also affected by a sharp correction in the global technology sector. When SVB failed to raise funding of $2.25 bn to cover its losses, this led to a run on its deposits and the closure of the bank by the FDIC (Federal Deposit Insurance Corporation).

This collapse was quickly followed by the closure of cryptocurrency sector lender Signature Bank, when US regulators shut it down in a bid to prevent the spread of the crisis. Signature was the second largest bank to the crypto industry, after Silvergate, which also announced its impending liquidation in March.

In an FDIC insured bank, up to $250,000 is guaranteed. In SVB, reflecting the nature of its 40,000 strong client base, around 93% of deposits were over this threshold. However, the US Treasury Secretary instructed the FDIC to make whole all depositors with both SVB and Signature bank, out of its Deposit Insurance Fund (a cost borne by a levy on banks). The aim is to shore up confidence among all US bank depositors.

The Federal Reserve then introduced a new lending facility to provide additional funding to banks with liquidity problems.

Credit Suisse

In Europe, Credit Suisse (CS) had to be acquired by its larger competitor, UBS.

For CS, problems had been building for some time, due to a series of scandals, including the largest trading loss in its 167-year history after the implosion of Archegos Capital, and the closure of $10 bn of investment funds linked to collapsed financial firm, Greensill.

It was then revealed that the CS auditor, PwC, had identified material weaknesses in its financial reporting controls, delaying the publication of its annual report. As a result of the collateral damage from this the Swiss central bank provided a liquidity injection of 50 bn Swiss francs (about US $54 bn) to shore up market confidence. Things moved quickly and Credit Suisse was taken over by UBS, to create a banking leviathan. To compound the fallout, $17 bn of bonds were wiped out.

Why should we care?

One of the most alarming symptoms of the 2008 global financial crisis was the huge pressure emanating from the banking sector. This had major repercussions for many stakeholders: governments, businesses and individuals.

In 2023 the fundamental problem is that interest rates have gone up aggressively over the past year, causing financial distress, sharp increases in bond yields and large drops in bond prices. The heavy concentration of bonds on the SVB balance sheet created a vulnerability, but there is a more general concern about bank regulation, particularly in the US. Certainly there are signs of a race to the bottom in this area, with businesses seeking listings in less regulated economies. With the fragility of the inter-connected global economy, if regulators in one key country loosen rules too much, then the whole world may suffer.

Central banks will continue to respond aggressively to try to contain issues, but a move away from the intoxicating effects of artificially low interest rates and a decade of Quantitative Easing was always going to cause problems and challenges. It is not 2008, but it still feels uncomfortable.

There are clear economic and business implications. The current difficulties are likely to increase the cost of funding for banks, pressurise profitability, and lead to tighter lending standards, reduced credit availability, and more expensive banking services.

Given the fundamentally important role played by banking in business, such outcomes will undermine economic activity and damage growth prospects.

Global central bankers now face a significant dilemma. Inflation is still too high, but continuing to increase interest rates against a background of global banking and financial market instability is a risky strategy.

This blog was created from recent News Bites by accountingcpd authors, John Taylor and Wayne Bartlett. News Bites are exclusively for accountingcpd licence holders. Find out more about our annual licence here.

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