Quickfire stick-ups
Just a year ago, the US central bank finally embarked upon its fight against inflation, whose existence it had denied for too long, considering it to be “transitory.” With hikes of 475 basis points bringing short rates to 5.00%, this is quite simply the fastest rhythm seen since the beginning of the 1980s. As is often the case, the ECB was slower off the mark, pulling the trigger in July 2022. The magnitude of the increase since then – 350 basis points – has never been seen before in the history of the institution founded in 1998. The primary aim of these brutal hikes has been to stifle inflation by slowing activity, but collateral damage to the global banking system has rocked markets in recent months.
The first victim was Silicon Valley Bank, where investments in long-dated bonds created a huge stock of unrealised losses. With deposits concentrated in the Californian tech ecosystem, which it had it had been instrumental in helping to finance and flourish, some form of geographical and sectoral solidarity might have been expected to protect it. Exactly the opposite was true as incendiary tweets and noxious emails created a self-fulfilling run on the bank – USD 42 billion of withdrawals in the space of a few hours, a level not previously seen. It’s worth noting that the previous wide-scale bankruptcy of a US commercial bank in September 2008 saw withdrawals of USD 17 billion over a period of several weeks. Online services and the acceleration of digital processes proved deadly, creating something akin to the first swipe crash in history.
Although medium-sized US banks initially suffered most on the stock market, Credit Suisse soon became the focus of attacks. Poor profitability, constant restructuring and numerous controversies made it the perfect target in an environment where the fear of losing was all that mattered. After CHF 110 billion of withdrawals by clients in the last quarter of 2022, the beginning of 2023 was hardly shaping up better.
Whilst these two banks are quite different in reality, they are a reminder that it is always liquidity crises that bring down financial institutions, however financially sound they may be. The concentration of deposits with a single type of client, whether Californian tech companies or high-net-worth individuals, creates high idiosyncratic risk. Intense and swift mistrust – whether or not it is justified – can floor the weakest players in a flash.
Whilst we believe that the European banking sector is, overall, much sounder thanks to better regulation and supervision, the consequences are now predictable: reduced loan volumes granted to the private sector, tighter credit terms, and an additional layer of regulation – a European specialty that has for once proved useful.
The banks are quite specific types of companies, whose financial health and stock market price depend on a number of factors – interest margins, diversification, brokerage, advisory business. But we should never forget that a sudden shortfall of confidence can break them.
Monthly editorial by Olivier de Berranger, Deputy CEO and CIO, La Financière de l’Echiquier (LFDE)