Banking Crisis 2023: Is Economic Recession Looming?
The Crash of the Regional Bank of the United States of America. Editor: Jasmine Tan
Jasmine Tan, Publicity Director
In the first half of 2023, the banking sector witnessed a series of failures, with four banks in the US and one Global Systemically Important Bank (G-SIB) collapsing. To counteract the rising inflation and moderate economic activity, the US Federal Reserve took measures to increase interest rates from 0.50% to 5.25% over a period of fewer than 14 months (Tepper, 2023). Such changes in interest rates tend to have a significant impact on the bond market, where existing bond prices immediately drop when the Fed increases rates. Consequently, the increased overall interest rates have a direct impact on existing bond prices, causing them to decrease. This adjustment in bond prices occurs as investors seek out comparatively lower interest rate payments that are more attractive when compared to the higher interest rate payments offered by new bonds that will soon enter the market (Curry, 2023).
Banks that receive a substantial amount of deposits in a short period tend to invest these funds into long-term maturity bonds such as US Treasury Bonds, which has low risk, given their high credit rating on S&P (AA+), Moody's (Aaa), and Fitch (AAA) (World Government Bonds, 2022). A bond rating serves as a measure of a bond's creditworthiness, which directly relates to the borrowing cost for the issuer. These ratings typically employ letter grades to signify the credit quality of bonds. Leading independent rating agencies such as Standard & Poor's, Moody’s Investors Service, and Fitch Ratings Inc. assess the financial strength of bond issuers, evaluating their ability to timely repay the bond's principal and interest. Bonds with higher ratings, often referred to as investment grade bonds, are considered safer and more stable investments. These bonds are associated with publicly-traded corporations and government entities that demonstrate positive outlooks. Investment grade bonds generally receive ratings ranging from "AAA" to "BBB-" by Standard & Poor's and from "Aaa" to "Baa3" by Moody’s (Chen, 2020).
Although government bonds have relatively lower risk compared to other forms of securities and derivatives, an increase in interest rates results in a negative correlation in bond prices, thus leading to a decrease in banks' equity on their balance sheets. This phenomenon, coupled with a decrease in depositors’ confidence, results in a bank run, where depositors withdraw their funds en masse from the bank. In such cases, banks have to repay depositors by selling long-term bonds prematurely, leading to significant losses. These factors eventually led to the failure of Silicon Valley Bank, which was the first bank to collapse during this banking crisis (Helmore, 2023). As the crisis persisted, it unveiled vulnerabilities within the financial system, especially among banks with imbalances between their assets and liabilities on their balance sheets. This exposed the weakest links in the chain, resulting in a deterioration of confidence among depositors and investors, ultimately triggering a cascade of bank runs.
A screen displays that trading is halted for Western Alliance on the floor of the New York Stock Exchange. Photograph: Brendan McDermid/Reuters.
The End or just the Beginning?
The US Federal Reserve has announced that the 0.25 point increase in interest rates in May 2023 might just be the final adjustment, implying that there will be no more rate hikes for the foreseeable future. This decision would have a significant impact on the US regional banks, as many are currently struggling and on the brink of collapse (Boesler, 2023). The pause in interest rate hikes may bring some much-needed relief to the regional banks, as they have been grappling with the impact of rising interest rates on their balance sheets. As the Federal Reserve has been steadily raising rates in an effort to combat inflation and moderate economic activity, the market prices of existing bonds have immediately declined. As a result, banks that hold these bonds on their balance sheets are experiencing a decrease in their equity levels, which can lead to a loss of confidence among depositors and investors, thus resulting in a bank run. Even if the hike on interest rate ends, it may take several years for these institutions to regain the confidence of the depositors and the public, as the crisis has eroded the long standing confidence that was built up over the years.
Several banks, namely PacWest and Western Alliance, might face potential failure in the near future. PacWest, in particular, has been under significant pressure following the collapse of Silicon Valley Bank in mid-March. This event triggered depositors to withdraw their funds from other mid-sized regional banks, causing PacWest to experience sharp declines in its stock prices. Since the beginning of 2023, PacWest's shares have plummeted by 76%. In an attempt to alleviate the financial strain, PacWest made a significant move in May 2023 by selling $2.6 billion USD worth of loans to the property investment group Kennedy-Wilson. However, this transaction came at a discount of $2.4 billion USD, indicating the extent of the financial challenges faced by the bank (Masters & Ralph, 2023). Similarly, Western Alliance has also witnessed a decline in its shares, with a decrease of 41% since the start of 2023. However, there is a glimmer of hope for recovery among regional banks. Western Alliance reported growth in deposits, leading to a surge in its shares by 10% during the week of May 17. Other regional banks also experienced positive gains, with PacWest BanCorp surging by 22%, Comerica Inc gaining 12.3%, Zions Bancorp adding 12%, and KeyCorp rising by 8.6% (Nishant & Oguh, 2023). These developments indicate a mixed outlook for regional banks. While PacWest's struggles and stock price declines raise concerns about its future viability, the surge in shares for Western Alliance and other regional banks suggests some signs of recovery. It remains crucial to closely monitor the financial health and performance of these banks in the coming months.
The road to recovery for regional banks may be long and arduous, and it will require a concerted effort from all stakeholders involved. Banks must take steps to restore confidence in their institutions, such as improving transparency, strengthening risk management practices, and diversifying their loan portfolios. At the same time, regulators must ensure that they are providing the necessary support to help these banks weather the storm. This could include providing funding through programs such as the Troubled Asset Relief Program (TARP) and implementing measures to encourage consolidation within the industry (Segal, 2020). Despite the challenges that lie ahead, the end of interest rate hikes could mark the beginning of a new chapter for regional banks. With the right strategies and support in place, these institutions may be able to emerge from the crisis stronger and more resilient than ever before.
U.S. financial authorities seized California's troubled First Republic Bank on Monday and sold it to JPMorgan Chase. | AFP-JIJI
Capitalising on Distress
The failure of Silicon Valley Bank has had a significant impact on the US regional banking industry. As a result, the shares of these banks have experienced a sharp decline, causing depositors to withdraw their money and shift their wealth to major banks (BBC News, 2023). This trend indicates that the total amount of assets in the banking industry is relatively constant despite the failure of several regional banks. The money is merely flowing from one bank to another. One major bank that has taken advantage of the current situation is J.P. Morgan Chase, which recently acquired First Republic in a similar fashion to their acquisition of the investment bank Bear Stearns during the 2008 financial crisis (Masters et al., 2023). The acquisition of First Republic will allow JPMorgan to expand its wealth management business and take on income-producing real estate loans, with the Federal Deposit Insurance Corporation (FDIC)'s loss-sharing deal reducing the risk.
The recent crisis has provided an opportunity for large banks to increase their dominance and market shares in the banking industry (Eisen & Ackerman, 2023). These banks are generally better equipped to weather economic storms and have the resources to acquire struggling banks, as seen with JPMorgan's acquisition of First Republic. Additionally, large banks can also increase their market share by attracting customers who are seeking the stability and security that these banks can provide. Major banks have established brand names and reputations that inspire confidence in depositors, making them a safe haven for those looking to protect their assets during times of crisis.
For a period, the former Göteborgs Bank was also located at Kungstorget 8 in Gothenburg. Photo by Eric Månsson from 1951 in Gothenburg City Museum's image collection.
Lessons from the Past
Banking crises have been recurrent throughout history, often sharing common underlying factors. These crises have affected various regions, including Asia and Europe, highlighting their global impact.
One notable example is the burst of the asset bubble in Japan during the late 1980s and early 1990s. This event was characterised by a speculative surge in real estate and stock prices, followed by a severe economic downturn. The rapid growth in asset prices was fueled by factors such as low interest rates and financial deregulation. However, when the Bank of Japan raised interest rates to combat inflation, asset prices began to decline. Consequently, financial institutions faced significant losses, leading to a banking crisis. The aftermath of the crisis included a prolonged period of deflation, stagnant economic growth, and the need for extensive government intervention (Nielsen, 2022).
Similarly, the Swedish banking crisis of 1991-92 had a profound impact on the country's economy. This crisis was triggered by financial liberalisation that commenced in 1985, allowing banks to lend without restrictions. A lending boom ensued, particularly in housing, commercial real estate, and the stock market, fueled by rising inflation and a tax system that incentivized borrowing. However, the boom eventually turned into a bust due to both international and domestic factors. The fixed exchange rate of the Swedish krona hindered effective monetary policy, while rising real interest rates influenced by German monetary policy and speculative attacks exacerbated the crisis. This led to deflating asset prices, weakened balance sheets, reduced private consumption and investment, increased bankruptcies, and a decline in the construction sector. Furthermore, the overvalued krona, problems in the export sector, declining tax revenues, and rising government debt worsened the economic situation. Bank credit losses surged from 0.2% to 7.5% of the total loan stock. Gota Bank experienced a minor bank run in April 1992, leading to the government guaranteeing Gota's obligations in September 1992, excluding equity (Makhija, 2022). Speculative attacks on Sweden's financial system intensified in the autumn of 1992, catching authorities off guard due to their limited understanding of financial markets and the consequences of deregulation. In November 1992, the Riksbank allowed the krona to float as a result. The crisis resulted in significant economic losses, surpassing the impact of the Great Depression in terms of real income decline and employment reduction. It also posed a threat to the financial system, leading to government intervention and the development of the Swedish model of bank resolution policy. The Swedish economy began its recovery in 1993, primarily driven by export growth (Jonung, 2009).
These examples highlight the recurring nature of banking crises and their wide-ranging consequences. They demonstrate the importance of understanding the root causes, such as speculative bubbles, financial deregulation, and inadequate monetary policies, to effectively manage and mitigate such crises.
Monetary Authority of Singapore. ST Photo: Lim Yaohui
Is Singapore’s Banking Industry Resilient to the US Banking Crisis?
In March 2023, the Monetary Authority of Singapore (MAS) issued a statement that affirmed the strong capitalisation and regular stress testing conducted by banks in Singapore to mitigate risks associated with interest rates and other factors. However, recent developments have raised concerns about the resilience of Singapore's banking sector. According to a report by Bloomberg in April 2023, a significant outflow of deposits occurred among foreign residents in March 2023, following the global financial turmoil that led to the collapse of multiple banks worldwide. Data provided by MAS revealed that within a span of just one month, foreign resident deposits experienced a substantial decline, plummeting from S$521.8 billion to S$22.2 billion. This marked the lowest level of deposits since July of the previous year. Additionally, commercial banks observed a decrease of about S$7 billion in the total outstanding loans and advances, which include bills financing. This brought the amount down to S$796.87 billion, marking the lowest level recorded since August 2021. These developments suggest that despite the robust risk measures implemented by local banks in Singapore, local banks still remain susceptible to the consequences stemming from the lack of confidence in the global banking industry among foreign customers. The recent financial turmoil has evidently eroded trust and prompted a significant withdrawal of funds from Singapore's banking system. This withdrawal reflects a lack of faith in the stability and reliability of the global banking sector as a whole. The challenges faced by Singapore's banks highlight the interconnectedness and interdependence of the global financial system. Even with Singapore's well-capitalised banks and diligent stress testing, the impact of global events can still reverberate throughout the country's banking industry. It underscores the need for constant vigilance and proactive measures to ensure the stability and resilience of the financial sector.
Moving forward, it is crucial for the Monetary Authority of Singapore and local banks to address the concerns raised by these recent developments. Restoring confidence among foreign customers will require concerted efforts, such as enhancing transparency, strengthening risk management frameworks, and fostering open communication channels. Moreover, exploring partnerships and collaborations with international counterparts can help mitigate the risks associated with global financial uncertainties. Despite the challenges, Singapore's banking sector possesses inherent strengths, including its robust regulatory framework, sound financial infrastructure, and skilled workforce. These factors provide a solid foundation to navigate through turbulent times and regain the trust of foreign customers.
In conclusion, while MAS asserts that banks in Singapore are well-capitalised and undergo regular stress tests, recent events have demonstrated the vulnerability of the local banking industry due to the lack of confidence in the global banking sector. The substantial outflow of foreign resident deposits and the decline in outstanding loans and advances reflect the erosion of trust triggered by the recent financial turmoil. Moving forward, proactive measures and efforts to restore confidence will be crucial for Singapore's banks to regain stability and strengthen their position in the global financial landscape.
Is Economic Recession Looming?
The ongoing developments in the financial industry have sparked speculation about the potential arrival of the next global financial crisis. Each passing day brings forth new revelations, drawing parallels between the current turmoil and historically-recorded financial crises. One key factor that continues to exert a significant influence on the fate of the financial industry is the lack of confidence among customers. This prevailing sentiment can shape the trajectory of the industry for the next few years. The similarities observed between the present turmoil and past financial crises are cause for concern. History has shown that lack of customer confidence can be a driving force behind the unravelling of the financial system. The current situation raises questions about whether the industry is on the precipice of another major crisis. As events unfold, market participants and regulators must remain vigilant and proactive in their efforts to safeguard against potential risks.
Looking ahead, it is imperative for stakeholders to remain attentive to the evolving dynamics of the financial industry. Effective risk management practices, enhanced regulatory oversight, and measures to restore customer confidence should be at the forefront of strategies employed by financial institutions and policymakers alike. By learning from the lessons of history and adapting to the changing landscape, the industry can mitigate risks and build a more resilient system.
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