Bank failures: Causes and Lessons
Overview
of bank failures
Silicon
Valley Bank (SVB), USA's 16th largest bank was closed on March 10
after it experienced a bank run i.e., depositors rushing to the bank to
withdraw their funds all at once. It is considered the second-largest bank
failure since 2008. SVB was specializing in lending to technology startups, and
it has invested a large amount in long-term debt like treasury bonds. When SVB
tried to raise cash to fulfill the need of venture-capital firms by selling
such assets it created market fear and uninsured depositors took notice of it
and started rushing to take deposits out of the system.
Second,
New York-based Signature Bank also shut down on March 12, 2023, after its
customers started withdrawing billions of dollars in the wake of the collapse
of SVB. The bank had considerable amounts of uninsured deposits and was exposed
to the crypto sector. It is considered the third-largest bank failure since the
2008 financial crisis.
Following
the two largest bank failures depositors at First Republic Bank, another US bank,
have been moving their money to larger institutions.
While two midsized US banks specializing in the
tech sector collapsed, Credit Suisse- Switzerland’s second largest lender and the 167-year-old bank is also
in trouble due to various mismanagement issues and other scandals it was
dealing with.
Similarly,
the value of banking stock has also been seen coming down and fluctuating this
time.
Responses
toward bank failures
While
people were panicking over the failure of two banks in the USA, US president
Joe Biden assured that the American banking system remains safe even after the
collapse of two U.S. banks and he would seek to hold those responsible and
pressed for better oversight and regulation of larger banks. And he promised no
losses would be borne by taxpayers.
The
Federal deposit insurance corporation (FDIC) in the USA earlier has only
guaranteed deposits of a smaller amount of about $250000, but at the advent of
such failures it guaranteed all deposits at the failed banks and Treasury
created a new facility to provide cash for banks suffering rushes of withdrawal.
Six central banks have announced that they would boost the flow of US dollars
to lessen the impact on the supply of credit. Such measures were taken only
during the 2008 financial crisis and at height of the COVID pandemic.
Credit Suisse- Switzerland’s bank is taken
over by its rival Union Bank of Switzerland in a deal encouraged by Swiss
authority to restore confidence in the Swiss banking sector.
Common
factors affecting the banking sector overall: rising interest rates.
The
central bank across the world has been increasing the interest rate to
stabilize the rising inflation created due to the COVID stimulus, Ukraine and
Russia war, the restriction against Russia by US and EU, and rising tensions
between China and India.
Such
a step of the central bank has reduced the market value of debt instruments
they were holding as assets and increased the cost of liabilities (White,2023).
Such misalignment between asset and liabilities resulting due to rising rates have
been affecting the overall banking system.
Comparison
of the current banking crisis and financial crisis of 2008
Failure
of bigger banks and declining banking shares have raised fears of a broader
economic downturn similar to the 2008 financial crisis. But the problems seen
in those banks are largely due to interest rate hikes and other
institution-specific problems. The situation is different from of the 2008
global financial crisis where there was an overall systemic problem in the
economy. Moreover, the regulation and capital of the current financial system
are more robust than before. Most experts believe that the problem seen in
those banks are not systemic and will be checked.
Lessons
from bank failures
The banking business runs
on trust. It can only last as long as people's confidence rest with it. Bank do
not hold all their assets in cash, it provides loan and advances and invests in
short-term and long-term assets. It simply tries to maintain an optimum balance
between the required liquidity and profitability. In case of loss in public
confidence and a situation like a bank run the banking model simply cannot
function and fails down. Similar was the situation seen in the banks mentioned
above. The banks could not fulfill the obligation of their depositors at the
time due to many depositors rushing for withdrawal.
Silicon Valley Bank was
highly focused on clients within a single sector i.e., fintech and crypto
businesses as well as venture capitalists. Its deposit and lending were
concentrated in the single sector. Similarly, its investment was more
concentrated in long-term government bonds and other government securities
which were severely affected by the increase in interest rates. It thus faced
the consequences of concentration risk, interest risk, liquidity risk, and lack
of overall management oversight.
Risks
of individual banks should be timely supervised. The effect of concentration in
any risk like in the current case interest rate risk should be avoided. Silicon
Valley had invested 60% of its money in government bonds like instruments. If
timely checked, its failure could have been prevented. The central bank should
be careful in raising interest rates and should ask banks to reduce their
interest rate exposure before rising interest rates if it can result in bank
failure or other spillover effects.
The
failure of those banks has no direct effect on Nepal but vital lessons on risk
arising from rising interest rates, the sensitivity of asset and liability
management, the necessity of timely supervisory review, and self-regulation
could be learned.
Way
forward for Nepal
In
the context of Nepal Nepal Rastra Bank (NRB) also has been raising interest
rates to curb the existing inflation. As per the Current Macroeconomic and
Financial Situation of Nepal (Based on Seven Months’ Data Ending Mid-February,
2022/23) published by NRB the weighted average lending rate of Nepal is about
13%, and inflation is about 7.28%. Considering the existing inflation, the
interest rate of Nepal cannot be considered too large. Similarly, the
investment portfolio of banks in Nepal is also not concentrated in a single sector
only.
NRB has specified a Single
obligor limit, sector-wise credit limit, individual/institution-wise deposit
limit, and other various prudential norms which have been protecting our
financial system from such unwanted shocks. Nevertheless, the current problem
in our banking system is more concentrated on working capital loans and their
use for other purposes such as imports, investment in real estate, and the
stock market. Due to the use of loans for other unproductive purposes Banks and
Financial Institutions (BAFIs) is often criticized for surged lending that has
contributed to the ballooning imports. To address this NRB issued working
capital guidelines to mobilize working capital for a defined purpose and reduce
the use of the loan in the unproductive sector. However, its effectiveness is
yet to be seen.
NRB's
prudent regulations and supervisory review of existing BAFIs have made them more
resilient than ever and the interest rate exposure of BAFIs is not a threat for
now.
While
a fall in the value of crypto assets caused a decrease in the value of assets
of banks considered problematic above, in the case of Nepal banks, people,
firms, or other companies cannot involve in such type of investment and it is
considered illegal. However, an effective legal framework and supervisory
capacity should be enhanced to check such type of investment in Nepal.
However
current problems like a protest against existing interest rates demanding loan forgiveness, the rise of fraud
and mismanagement by cooperatives, the inability to effectively increase
internal production and productivity with the flow of credit to the productive
sector, unhealthy competition between BAFIs to increase deposit is creating
challenges to our financial system to maintain stability in the long run. If such problems can be timely taken care of
the risk of bank failure can be avoided for a long.
References
Takami, K. (2023, March 20). U.S. bank turmoil
reflects blatant failure by the Fed, expert says. Nikkei Asia.https://asia.nikkei.com/Economy/U.S.-bank-turmoil-reflects-blatant-failure-by-the-Fed-expert-says.
Thompson,M.(2023,
March 20). Global
banking crisis: What just happened? CNN Business. https://edition.cnn.com/2023/03/17/business/global-banking-crisis-explained/index.html
Meyersohn.N.(2023,March
16). Credit Suisse: Why it’s struggling and why
that’s a big deal. CNN Business.https://edition.cnn.com/2023/03/16/investing/why-credit-suisse-is
struggling/index.html
White.C.(2023,
February 9). Rising Interest Rates
Complicate Banks’ Investment Portfolios. Supervising our Nation’s Financial
Institutions.
NRB. (2023,
February). Current Macroeconomic and Financial Situation of
Nepal
Haskell.J(2023,
March 14). Failure of 2 US banks
creates concern among customers at other banks of similar size. Eyewitness
news: Personal Finance. https://abc7ny.com/bank-failures-silicon-valley-signature-president-biden/12950505/
Comments
Post a Comment