The war on inflation claims its biggest victim yet

He’s not the only one noting similarities to past crises.

Fund manager Mike Mangan said there was a clear sense of deja vu for people who lived through the 2008 global financial crisis, noting that this week also marks the 15th anniversary of US investment bank Bear Stearns’ collapse — an early one Failure in the GFC.

“The sudden collapse of the SVB is reminiscent of the collapse of Bear Stearns on March 16 [March] 2008,” Mangan said in his regular email note.

Yet despite these worrying parallels, there are major differences between now and 2008 – most notably the regulators’ swift and decisive response to calm the market’s nerves.

Experts also insist Australian banks will not face the same serious problems that hit some smaller US banks this week. Instead, the US banking turmoil mainly impacted global market sentiment, including a debate over what the turmoil means for interest rates.

A victim of higher interest rates

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SVB specialized in start-up technology companies, but the ultimate trigger for its demise was decidedly old-fashioned: a bank run.

The rapid rise in interest rates played a fundamental role in triggering this crisis of customer confidence, alongside a business model that experts say was deeply flawed.

In times of cheap money, the SVB had created a lucrative niche for technology companies, which helped many start-ups to boom. Near-zero interest rates meant that investors tended to invest heavily in speculative ventures, hoping for a long-term payoff.

However, rising interest rates meant that this capital dried up, so that more and more SVB customers made use of their deposits. At the same time, the SVB was unusual in two ways. First, it held far more deposits than it borrowed. Second, it invested that excess deposit money heavily in government bonds — assets that have fallen in price as interest rates have risen.

As more troubled tech companies began withdrawing their deposits from the bank, SVB was forced to sell assets, and last week it sold a $21 billion bond portfolio at a $1.8 billion loss Dollar. That loss was the last straw, triggering a breach of confidence that prompted regulators to close the bank in days, marking the second-biggest U.S. bank failure in history.

The sudden collapse sent shockwaves through global stock markets, including in Australia. But despite these market shocks, bankers and regulators were quick to point out major differences between the SVB and our banks.

ANZ’s Elliott says the circumstances that brought down SVB simply couldn’t have happened here and he remains “very optimistic” about Australia.

For one, Elliott says Australian banks are forced to recognize all changes in the value of their bond portfolios as soon as they are recognized through an accounting method known as mark-to-market. This means losses banks make on bonds don’t shock investors as they are reported over time.

“If they had been regulated in Australia, these [SVB] Losses would have been reported gradually over the past year or so. And so it would not have been a surprise and they would have had to add capital and liquidity along the way. So it literally can’t happen here,” he says.

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Additionally, Elliott says that unlike SVB, Australian banks do not have pools of excess deposits from which they seek to generate returns by taking additional risk in financial markets. “None of the banks here have excess deposits, so none of us are in this business.”

Local banking analysts echoed this view that Australian banks were unlikely to suffer as much as SVB did from rising interest rates.

Morningstar’s Nathan Zaia highlighted the concentration of SVB deposits in one particular group – technology companies – and also their heavy investment in bonds: “We do not believe that the conditions that have enabled a run on SVB exist for Australian banks .”

The dramatic failure of the SVB has also exposed major cracks in US banking regulation, but local experts have far more faith in Australia’s regulatory system.

Mark Nathan, portfolio manager at Regal Funds Management, stresses that Australian banks are subject to much stricter regulation than the smaller players that have collapsed in the US. He doesn’t think the episode will lead to major changes in the Australian banking landscape.

“The regulation and governance of some small banks in the US is different than what we have in Australia and the UK. Australian banks and UK banks are in a much better position in terms of supervision.”

Systemic risk?

But what about the risks to global markets? Could this week’s turmoil in the banking sector be an early sign that a broader crisis is brewing in the global financial system?

That’s the question investors, bankers and governments are asking after this week’s events – and no one can honestly know the answer.

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But experts say there are critical differences between today and what happened in 2008, and this gives hope that the world can escape a full-blown financial crisis.

Perhaps the most significant difference is the firm response from regulators, who have acted much faster to restore confidence than they did in 2008.

The U.S. government not only guaranteed all deposits held by the SVB — including those that exceeded the $250,000 threshold for insured deposits — but also launched a program that gives U.S. banks a stream of funding to meet any further demand for withdrawals from the SVB to satisfy the public.

A senior banker, not authorized to speak publicly, said: “It’s hard to imagine how they could have done more.”

Elliott says the quick response to SVB’s failure was “dramatically” different than regulators’ response to the early shocks of 2007 that the GFC announced, and he says governments learned from the 2008 crisis.

In Switzerland, the country’s central bank allowed Credit Suisse to lend up to 50 billion francs ($81 billion) to boost confidence in the struggling giant.

Notwithstanding the problems at Credit Suisse, which has struggled for years, others also argue that the banking problems appear to be largely US-specific.

US-based Macquarie analyst Viktor Shvets pointed out that bank failures are not that uncommon in the US because there are thousands of banks and a confusing regulatory structure that bank executives exploit when looking for growth. In fact, between 2018 and 2020 eight banks with assets of $672 billion – about three times the assets of the SVB – failed.

“Given that the US has about 4,700 banks under different statutes, regulated by different laws and overlapping regulators, it’s surprising that defaults aren’t more common,” Shvets said in a note.

But while this week’s drama is largely confined to US banks, there are clear implications around the world, including here. Of paramount importance to many households, the episode has led to predictions that central banks may be more cautious about raising interest rates for fear of creating more financial instability.

Banking analyst Azib Khan of Evans and Partners says the Federal Reserve’s firm response — including turning on funding for banks — creates a “conundrum” for interest rates.

“On the one hand, they raise interest rates, which is getting worse. But then they’re willing to inject that money into the system for bailouts. So what are they doing? Do they tighten or loosen?” he says.

Markets increased bets this week that Australian interest rates are nearing their peak, with some economists predicting a pause next month. On the other hand, recent public statements from the Reserve Bank indicated that it believed interest rates should continue to rise.

Elliott says it’s a tough decision for central bankers as they fight inflation, but given recent events he sees a case for pausing and assessing how things settle. “The risk is there [that] They might just make things worse. Is a month important now? Maybe just take a month and see it.”

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