It sounds like a cliché but there is never a dull moment in markets. Not too long ago most people were unaware of what SVB (Silicon Valley Bank) was, including me. Today everyone is an expert with reems of analysis as to where it all went wrong! It has been a tumultuous month for markets starting with several small/mid-sized banks in the US shutting down and depositors redeeming their money as questions about the viability of these banks gained momentum. This was topped off with one of the cornerstone establishments of Swiss banking Credit Suisse being bought out by UBS to avoid a banking collapse and possible contagion across the global banking sector. The story didn’t end there as Credit Suisse AT1 debt holders (equivalent to Australian hybrids) got wiped out with assets being written down to zero while equity holders retained some value. This put the whole notion of the capital structure into question where debt holders are meant to rank above equity holders which created more volatility in markets and forced the European Central Bank and the Bank of England to come out to reassure markets by stating that the traditional capital structure remains true and that the Credit Suisse AT1 debt issue is isolated to Switzerland’s unique banking rules.
For many the current banking melodrama is invoking bad memories of the global financial crisis (GFC) of 2008. It is important to note that the banking sector has significantly de-risked since 2008 notably in terms of Tier 1 capital ratios which have increased substantially since 2008 following the Basel III banking framework which was brought in post the GFC in order to strengthen the banking system. One of the issues with banks such as SVB was a lack of governance and oversight by the US regulator, which contrasts with the Australian banking sector which has largely adopted the Basel III requirements. Another notable difference from the GFC was that central banks reacted quickly to the current crisis, unlike in 2008 where central banks dragged their heels until the banking system was on the verge of breaking.
So, are we out of the woods? It seems that the swift action of central banks has settled markets for now. The broader risk remains contagion and like many significant events in history while they don’t necessarily repeat, they do rhyme and I have no doubt that there are many nervous bankers out there taking a good look at their business models and capital reserves.
From a practical perspective we would expect the cost of debt to rise as a result of the banking issues. There is a view that this would in effect be the equivalent of two rate hikes and that it may trigger central banks to take a more dovish stance in raising rates to fight inflation. To date there is no evidence of this and central banks commentators have tried to delineate between stability of the system and inflation. However, one cannot dismiss the notion that the rapid rise in rates has exposed cracks in the markets with the current banking issues an example of this.
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