As soon as news emerged that Silicon Valley Bank (SVB), the 16th-largest lender in America, with about $200bn in assets, went bust, a dark cloud loomed on the horizon of the international financial sector. Even when the initial shock started wearing off following swift actions from central banks, following the collapse of SVB and Credit Suisse, the dust has not settled yet.
Pieces are still moving on the chessboard. Recently, Sergio Ermotti returned to UBS, the bank that merged with Credit Suisse. Officially, Ermotti will help the bank navigate such a hasty takeover. Critics quickly pinpointed that Ermotti was brought back from his cushy job at Swiss Re because of his capacity to handle difficult situations and put out fires, which means there is still much to be done. Meanwhile, Ammar al-Khudairy of the Saudi National Bank, whose comments led to investor panic that caused the emergency takeover, has resigned.
At this point, a financial crisis on the magnitude of the one in 2008 – 2009 does not seem likely. But the recent turmoil still confirms one thing: Global financial markets are fragile and prone to crisis. Since this is the case, as Paolo Pasquariello, Professor of Finance at the University of Michigan, puts it, “We need to make the system as fire-proof as feasible while being ready to extinguish fires when they occur.”
Firefighting is exactly what central banks have done so far, offering credit lifelines and tumbling bank shares. The Swiss National Bank facilitated the UBS takeover of Credit Suisse. Since the fire seems to be put out, “One can start worrying about catching any arsonists,” observes Pasquariello.
Now, it is time to make life as difficult as possible for arsonists and, more importantly, to make the financial markets as fire-proof as possible.
Ironically, bankers, who were responsible for the crisis to begin with, are the ones tasked to stabilise financial markets.
It is important to note that the relaxation of banking and finance regulations in the US is one of the main reasons behind SVB’s collapse. During Trump’s presidency, some banking regulations were rolled back through the Economic Growth, Regulatory Relief, and Consumer Protection Act, which was signed into law in May 2018. Specifically, some rules put in place after the 2008 financial crisis to prevent another financial collapse were softened or eliminated, such as those related to executive compensation and capital requirements for smaller banks. This rollback has been criticised by some, including Senators Bernie Sanders and Elizabeth Warren, for potentially increasing the risk of another financial crisis.
This self-fulfilling prophecy by the aforementioned senators is what happened with SVB. Because of the softening of regulations, the latter accumulated risks which reached an unacceptable point, leading to the bank’s collapse.
In sum, easing regulations was the cause, but the cure is still to be found in regulations. Stricter limitations will prevent risks, but they must also be well-calibrated to not create unnecessary costs for the banks.
But regulations are only one side of the coin. The other side is inflation. Increasing interest rates to fight inflation is another trigger for the current banking crisis. Higher rates made it difficult for SVB to finance itself and damaged the value of its loans and assets. Ultimately, this led to the bank’s collapse.
Paradoxically, without regulations and policies, the economy would also suffer. The problems would come in the form of a recession or, worse, stagflation, leading to more bank collapses. Therefore, policies such as increasing interest rates can be problematic for some actors, but ultimately, it leads to the preservation of the system by keeping the economy running.
(In)Actions Come with a Consequence
One thing is worth remembering while analysing and drawing lessons from this crisis: Every action and inaction, be it for putting down the fire or making the system fire-proof, will have consequences. Central banks’ efforts addressing the crisis have their flows. Above all, such actions might encourage banks to take excessive risks knowing there will be a helping hand from the central banks. However, “In absence of these actions, we ordinary citizens would be much worse: long lines to withdraw whatever is left of our deposits; unemployment; a depressed housing market; and less easy access to credit to fund economic activity,” warns Pasquariello.
The same logic applies to (in)actions to prevent future crises. Such measures will be costly, for sure, but there will be benefits to them too. Therefore, what states and central banks need to do right now is to assess costs and benefits and act upon them before it is too late.
This article originally appeared in the opinion section of the website Middle East Monitor.