Are we encountering a systematic banking crisis?
With digital technology providing instantaneous information to our phones, computers, televisions, and smart watches, it is difficult not be overwhelmed with information and how to decide what is relevant. As the world’s economies adjust after the global pandemic, and to environmental disasters, conflicts, and cost of living pressures, they must now also consider the risk of a systemic banking crisis. However, it is important that we understand what a banking crisis is, to what extent it is or is not happening and, perhaps more importantly, what it means to our ongoing financial decisions and banking relationships.
Banks are inherently susceptible to a range of risks, such as poorly performing loans, customers unexpectedly withdrawing their deposits, volatile interest rates, material reductions in asset values (such as property) and increased numbers of insolvencies. Some of these will lead individual banks to falter, which may result in the need for additional share capital and / or regulatory intervention. For most businesses though this is part of the economic lifecycle, where some are successful, and others are not. But when a bank fails the impact to its customers is far reaching. Customer confidence quickly erodes and account holders, understandably, seek to withdraw their deposits at a time when the bank needs them most. This perpetuates a downward spiral which, with digital online banking, can result in withdrawals taking place very quickly - with digital withdrawals replacing the physical scenes we remember from 2008 of customers queuing outside high street banks to withdraw their savings.
So should we be concerned about the recent events with Silicon Valley Bank, Signature Bank, First Republic Bank, and Credit Suisse? The obvious answer to this is a resounding “yes”, but we should also reflect on what has changed since the last systemic banking crisis in 2008. Systemic failure is different to a small number of single, isolated events. In 2008 there was global contagion in the banking sector as customer confidence fell and even institutions that were performing well were adversely impacted. What we have seen so far in 2023 is a small number of explainable failures, with early intervention by regulators to limit the impact to consumers. This is a positive effect of the enhanced regulatory requirements implemented since 2008 to ensure banks operate to more stringent controls, with improved capital and liquidity levels which fundamentally underpin the ability to meet customer withdrawal requests. Whilst it is not possible to fully remove the risk of a bank failing, additional measures to help regulators implement recovery steps, or mitigate the impact if a bank is ultimately unviable, seem to be proving effective. On this basis it is reasonable to conclude that we are not likely to encounter a systemic banking crisis, such as was seen in 2008.
For customers there will still be some inevitable concerns. “Who should I bank with?”, and “Is my money safe?” are reasonable questions to ask. By adopting some sensible research and undertaking appropriate due diligence it is possible to significantly reduce the risk. 2008 taught us not to rely blindly on an institution’s credit rating but to look to other factors too. These should include the type of licence a bank holds, and whether it participates is a depositor protection scheme.
Compensation schemes will ensure that some or all of a customer’s deposit balance is protected in the event of a bank failure and different countries will have different schemes. Not all banks participate in them though and not all types of customer are covered. However, a customer can check a bank’s status, and whether their deposit is covered, from publicly available information.
For customers of smaller banks it may also be important to understand who their counterparties (the other institutions they transact and place deposits with) are, to ensure their underlying risk profile is comfortable. Having a good relationship manager also adds real value, especially where they become a customer’s trusted advisor. Openly sharing concerns about the types of deposit protection available, or perhaps financial pressures impacting your ability to pay a loan or a mortgage, at an early stage can prove to be very effective at mitigating risk.
With inflation in the UK now forecast to start declining, and interest rates likely to fall as a result, there may be positive news for bank customers in the medium-term. In the meantime, whilst economic forecasts are not absolute in nature, we should employ a watching brief during the months ahead to try and anticipate changes to the financial landscape. Together with continued good regulation, calm and considered business decisions, and effective due diligence, we can all play an effective part in avoiding a future systemic banking crisis.