The other day, Janet Yellen, the US Treasury Secretary, answered questions before the US Senate Appropriations Subcommittee, where she had to face questions about the stability of the US banking sector after the bankruptcy of Silicon Valley Bank and Signature Bank. Among other things, she told senators that she did not plan to guarantee all bank deposits without congressional approval.

The good news about the change in the rules for the benefit of the bank’s customers has stopped

After two bank failures in one week, the collapse of Silicon Valley Bank, Signature Bank and First Republic Bank in the US, as well as the collapse of Credit Suisse in Switzerland, despite the urgent mobilization and support of central banks, trust in banks is once again disappearing. in financial markets.

How is this possible now, when so much has been done to strengthen banks since the 2008 crisis? Perhaps Silicon Valley Bank is nothing more than a classic case that proves that it is liquidity risk that can lead to bank failure. But perhaps the problems arise elsewhere.

Case I: Silicon Valley Bank faced two simultaneous risks: interest rate risk and liquidity risk. The bank’s vulnerability resulted from the fact that it held a large portion of uninsured deposits and a large portion of deposits invested in very low-interest held-to-maturity Treasury bonds. But since March 2022, the US Federal Reserve has aggressively raised interest rates – currently by 4.5 percentage points – in an attempt to control rising inflation.

As a result, the yield on one-year US Treasuries hit a 17-year high of 5.25 percent in March 2023, up from less than 0.5 percent in early 2022. The yield on 30-year Treasuries rose almost 2 percentage points.

This rapid rise in interest rates in such a short time has caused the market value of debt obligations issued prior to this aggressive Federal Reserve interest rate policy, whether corporate bonds or government Treasuries, to fall, especially for those with longer maturities. . In a situation where the owner of old, low-yielding securities, in a rush for liquidity, must sell them to maturity at a time when the market value is below par, he will record a real loss.

So, as SVB’s customers withdrew their deposits beyond what the bank could pay using its own cash reserves to meet its obligations, management decided to sell $21 billion of the bank’s securities portfolio at a loss of $1.8 billion. The need to raise equity led the lender to try to raise more than $2 billion in new capital, rumors spread, customers became suspicious, and the collapse began. By design, banks cannot return all deposits to their customers immediately, at the same time. As customers lose confidence in the safety of their funds, panic sets in and banks collapse.

Case II. As for the collapse of Credit Suisse, the bank was hit by years of scandals and losses and struggled with a crisis of confidence for months before its demise was sealed just days ago last week, when Swiss authorities brokered a takeover of the bank by larger rival UBS.

Due to the lack of good governance, among other shortcomings, Credit Suisse reported a loss of $1.7 billion in 2021, nearly $7 billion in 2022, and forecasts for another significant loss in 2023. But the bankruptcies of Silicon Valley Bank and Signature Bank, as well as fears about the reliability of banks caused by the US bankruptcy, made Credit Suisse investors take a closer and less friendly view. Such a contagion due to the loss of customer trust.

The collapse of Silicon Valley Bank (SVB) in March 2023 shook the global banking industry. Banking institutions in countries where central banks follow a similar policy of raising interest rates in their anti-inflation campaigns today face interest rate risk for some of their assets, ie some government or corporate securities held in portfolios.

But the systemically important question is not why Silicon Valley Bank was not wise enough to hedge the interest rate risk of these bonds in its portfolio by hedging (even if it costs). Like the question of why Credit Suisse jumped from one crisis to another in just a few years.

Why and how the bankruptcy of two small banks (less than 0.5% of global banking assets) can threaten the entire system

Investors quickly fled, moving their funds to other banks that were considered safer, indicating that they do not believe that the current rules are enough to stabilize the system.

Does the fact that all banks are now under pressure indicate that financial market participants, that is, those professionals who are well informed and familiar with the banking system, do not believe that prudential rules are sufficient to ensure systemic stability? Probably so, and here are two main reasons for this.

One reason is regulatory, and here we will refer to the regulatory framework provided by Basel III. Simply put, Basel III is an internationally agreed set of measures developed by the Basel Committee on Banking Supervision in response to the 2007-2009 financial crisis. The measures are aimed at strengthening the regulation, supervision and risk management of banks and, among many technical requirements, also set certain minimum capital adequacy ratios in banks in order to create bank liquidity and limit leverage.

But both US and EU legislatures have made significant departures from internationally agreed frameworks through Basel III. Thus, in the US, Basel III does not apply to US small and medium-sized banks.

A law passed in 2018 raised the prudential threshold for banks from $50 billion to $250 billion. To prevent a repeat of previous scenarios, after the 2008 crisis, the Basel Committee introduced new legislation aimed at restricting the activities of so-called global systemically important banks, also known as systemically important financial institutions. These are classic banks from the “too big to fail” category, but are considered only on a global scale.

And here is the second reason, which is the inadequacy of regulation: Basel III treats banks as separate entities, not as relationships between them, and this is a huge vulnerability, given the current high interconnectedness of the global banking system, which is much larger. than in 2008.

But when prudential regulation fails, the last line of protection for society against the consequences of bank failure is bank bailout. This occurs when the authorities determine that the failed bank cannot go through normal bankruptcy proceedings without harming the public interest and financial instability, and try to salvage as much of what can be salvaged as possible.

That’s what happened last weekend in the deal struck by Swiss authorities to buy UBS Credit Suisse on unprecedented terms: UBS bought Credit Suisse for $3 billion, while Credit Suisse’s book value was $45 billion in equity. It turns out that UBS bought Credit Suisse at a discount of more than … 90%!

Monte dei Paschi di Siena, Banca Veneto, Banca Popolare di Vicenza, Banca Carige (Italy) and NordLB (Germany) were bailed out with public funds

Recently, the US authorities did much the same, guaranteeing deposits above $250,000, which exceeded the insurance limit of Silicon Valley Bank and Signature Bank. While this was good news for Silicon Valley Bank and Signature Bank depositors, it was basically just some emergency measures by the authorities to prevent contagion, and it shows that, unfortunately, we live in a world where there is no such small bank anymore to go bankrupt. without saving

This happened before, and not so long ago, when Monte dei Paschi di Siena, Banca Veneto, Banca Popolare di Vicenza, Banca Carige (Italy) and NordLB (Germany) were bailed out with public funds.

Even if the details of each individual situation are different, the principle is the same: public money goes to bail out banking institutions that are not exposed to systemic risk, or to the institutions of their private creditors. The reality is that financial market participants, although they are well aware that they must comply with the existing rules, see that government authorities are forced to intervene whenever the situation becomes critical. And the emergency pumped money goes into private pockets, “too tested by adverse circumstances”, and the losses are covered by state budgets and central banks, in other words, society.

Following the recent events in the USA and Switzerland, on 21 March the ECON Committee of the European Parliament organized a public exchange of views with José Manuel Campa, President of the European Banking Authority (EBA) and Andrea Enría, President of the Central Bank Supervisory Board. European on the consequences of the collapse of Silicon Valley Bank for financial stability in Europe.

This is somewhat ironic, as the European Parliament’s Committee on Economy and Economics blatantly ignored the two organizations’ warnings and watered down Basel III when it voted on the EU’s banking package on January 24, despite warnings from the European Union’s top watchdogs, which can be read. here.

From the perspective of events in the US and Switzerland, the situation should actually be the other way around: financial market watchdogs should be questioning lawmakers who systematically mock the consequences of laws and regulations originally designed to prevent financial catastrophes. This happened before the 2008 crisis due to deregulation, and it is happening now due to the dilution of Basel III.

And then we ask ourselves: because of whom is every crisis? To the industry, to the customers, to the legislature, to the decision makers, or … to the human side that doesn’t believe in the rules, but believes in the possibility of winning more by breaking them?

N. Ed: Kalu Monika is a lawyer specializing in consumer law with more than ten years of experience in this field. She specializes in protecting the rights of consumers of financial services, and her field of competence includes banking contracts, insurance contracts, regulation of the rights of consumers of financial services in national legislation and legislation of the European Union. He also holds a bachelor’s degree in economics. She is the founder and president of the United Consumers Association and a member of the Banking Stakeholder Group (BSG) of the European Banking Authority (EBA) and the Insurance and Reinsurance Stakeholder Group (IRSG) of the European Occupational Insurance and Pensions Authority (EIOPA). ), representing consumers. He is an independent member of the international public organization Finance Watch.