The world’s top policymakers and international financial leaders acted effectively in the days following the collapse of California’s Silicon Valley Bank, widely known as SVB, on March 10 and others and appear to have dealt with the risk of wider global financial contagion, at least for the moment. The troubled bank which triggered the global financial shock reopened under new ownership – the North Carolina-based First Citizens Bank – on March 27.
The SVB collapse became the second-largest bank failure in American history and the largest bank failure since the 2008 financial crisis. The news of a run on the tech-friendly SVB’s deposits was followed in rapid succession by two other events which generated a confluence of events almost producing a global meltdown – but not quite.
First came the closure of New York-based Signature Bank on March 12, which almost immediately came under the control of the Federal Deposit Insurance Corporation (FDIC) which had assumed control of SVB just two days earlier in order to protect depositors’ assets.
The closure of Signature Bank constituted the third largest US bank failure so far recorded. Signature Bank was notable for its heavy exposure to cryptocurrencies, which at one time constituted a quarter of its total assets, but was also involved in real estate and digital asset banking. Signature Bank was also known for its previously close relationship with former President Donald Trump’s business empire, although links were reduced sharply after the January 6, 2021 riots in Washington.
Since the FDIC issued the closure order on March 12, Signature Bank has been managed by Flagstar Bank, a subsidiary of New York Community Bancorp. Although Signature had been steadily moving away from heavy involvement in cryptocurrencies, its failure has been interpreted as yet another no-confidence vote in that shadowy financial exchange medium.
Federal regulators have made it clear that the management teams of SVB and Signature will not be receiving the same protections given to the banks’ depositors – full FDIC insurance – nor will the banks’ stockholders. Management malfeasance has not been ruled out in either closure but most analysts focus on the banks’ poor responses to the challenges posed by steadily rising interest rates seen over the course of 2022 and failures to hedge adequately, which is of course a problem not limited to the banks closed so far.
The FDIC itself is reportedly considering issuing a special assessment in the near future to its member banks to replenish its coffers — as it receives no federal funding — after the latest bank rescues.
Credit Suisse closure – the shockwaves reach Europe
Shockwaves from the mid-March US banking closures played a role in precipitating the shutdown of Credit Suisse, previously Switzerland’s second-largest bank, although Swiss officials are understood to have repeatedly overstated the impact of those US-sourced shocks on an already-scandal-ridden Credit Suisse.
In the midst of continuing extreme market turmoil throughout the week after the American banking closures, shares of Credit Suisse plummeted drastically following an admission the bank had found certain undisclosed “material weaknesses” in its financial reporting for 2021 and 2022, some of which effectively hid the extent of deposit withdrawals in late 2022.
Market reaction to this prompted an urgent announcement by Swiss banking regulators that the bank met all current capital and liquidity requirements. All of this occurred while many other European bank stocks were also dropping sharply and investor confidence in bank regulators was near rock bottom.
The final trigger event appears to be the announcement on March 22 by the Saudi National Bank, Credit Suisse’s largest investor with nearly 10 percent of the company’s shares, that it could not provide additional funds to stabilize Credit Suisse. To avert a collapse, an emergency rescue plan was then imposed by Swiss banking regulators which saw a buy-out by UBS, or the Union Bank of Switzerland, for $3.3 billion, although the deal — not approved by shareholders — was officially categorized as a “merger.”
UBS has indicated some parts of the new acquisition will be sold off as consolidation proceeds. While stability has returned for the moment, it remains unclear how much this chain of events will tarnish Switzerland’s financial center reputation.
Back in the US, mid-March saw two other important developments which flowed directly or indirectly from the SVB collapse. First was a general freeze in new start-up funding as a result of market instability following the SVB closure, although there are numerous reports that indicate that fresh venture start-up funding was broadly declining already.
The second development was the March 23 rescue of the distressed First Republic Bank, based in San Francisco, by a consortium of large US banks for $30 billion, characterized as a cash injection, not an actual acquisition. Reportedly JPMorgan Chase led the rescue effort which includes Bank of America, Wells Fargo, Citigroup and Trust Bank, with heavy encouragement from Treasury Secretary Janet Yellin.
Is the worst over?
Central banks around the world have been stressing that the global banking system is safe and lenders are well-capitalized. Nevertheless, financial markets are worried that there could be other problems in the banking sector that have not yet emerged. While large banks appear to be well-capitalized, fears remain that weaker American regional banks, as well as some overseas, may require support in the near future as interest rates continue to rise.
The Fed’s conundrum
The US Federal Reserve Bank’s task of controlling inflation without triggering a recession was already a difficult assignment before the SVB crisis added a new element into the mix, uncertainty over the global banking sector’s ability to handle the steadily rising interest rate environment. Tomes were written in the days before the Fed again decided to raise interest rates on March 22, but only by 0.25 percent, focusing largely on the perceived inability of troubled segments of the US banking sector to manage another rate hike.
All of this fear-mongering proved to be incorrect, and Fed Chair Jerome Powell’s assessment that the US banking system was essentially sound won the day, even though the Fed has clearly signaled that there should be a pause in further rate increases, although not an outright end.
The Fed’s March 22 rate increase was the ninth in the current cycle of rate jumps, and that small increase was interpreted as an attempt to balance inflation risks with the threats of ongoing banking sector instability and a credit crunch that could precipitate a new recession, instead of the Fed’s desired “soft landing.” Fewer and fewer market analysts see the “soft landing” scenario as likely now, but much depends on how the US banking sector responds to current conditions and whether there will actually be a credit crunch, something the Fed is watching carefully.
Central banks took their cues from the latest Fed decision
Global coordination on interest rate policy is nothing new or unusual, at least for the major developed countries making up most of the G-20 and key trading partners. US rate increases were immediately followed up by increases in the UK, Switzerland, Norway and Saudi Arabia. The European Central Bank had already raised its rates on March 16, in the midst of the first week of global market turmoil.
Putin and Xi take ineffective potshots at the US dollar
Meanwhile, in Moscow, Russian President Vladimir Putin and visiting Chinese President Xi Jinping used their three-day meeting on March 20-22 to expand joint efforts aimed at shifting global economic dominance away from the US and especially the US dollar. While not specifically linking their projects to the ongoing banking crisis and interest rate concerns, the two leaders worked to capitalize in any way possible on fears the US dollar could be losing its status as the world’s reserve currency, primarily by detailing the rapidly increasing use of the Chinese yuan to replace Western currencies in surging bilateral trade.
The West’s Ukraine invasion-linked sanctions have frozen Russia out of large segments of the dollar and euro-dominated Western economic sphere, while bilateral trade transactions denominated in the Chinese yuan have surged over the past year. As sanctions continue, Russia may in fact be gradually drifting into a yuan-currency zone while most other payment options remain cut off. But it is a fool’s errand to attempt to label that temporary response to western sanctions, which includes major shifts in energy and consumer goods trade, as a sign the dollar is losing its reserve currency status. And it will be even harder to convince any leaders in the “Global South” to believe this new mythology.