How bad is the banking crisis?

People walk by the New York headquarters of Credit Suisse on March 15, 2023 in New York City.

Spencer Platt/Getty Images

• On Sunday, UBS acquired the embattled Credit Suisse for $3.25 billion.
• The Fed along with five other central banks announced coordinated action to reassure global banks.
• While immediate contagion risks seem to have been contained, concerns still linger over what the next blind spots are.

You know something is wrong when six big central banks from around the world decide to join hands in order to reassure financial markets. That too on a Sunday night.

Hours after UBS announced it will acquire Credit Suisse for $3.25 billion, the Federal Reserve, along with the European Central Bank, the Bank of England, the Swiss National Bank, the Bank of Canada and the Bank of Japan announced fresh measures to ensure there is enough funding for global financial institutions amid the current stressed market conditions.

American economist Nouriel Roubini, or "Dr Doom" as he is often referred to, broke down this measure in a tweet.

"Use of Fed international swap lines spikes during severe risk off episodes when there is shortage of global dollar liquidity: GFC, EZ crisis, temper tantrum, Covid 3/20 shock. Expect another likely spike now. That is why the CBs coordinated action today," Roubini tweeted Sunday night.

It's wild to even think that the current market situation is similar to the ones mentioned on Roubini's list. But the events in the past two weeks have investors - both institutional and retail - worried over financial stability and the fate of the economy.

"Just how bad is the banking crisis?" is a question we have heard being asked many times since the collapse of the Silicon Valley Bank (SVB).

In less than two weeks, two US banks - SVB and Signature Bank, and a big global lender like Credit Suisse have collapsed, bringing back fears of a full-blown financial crisis.

So how big is this crisis then?

"Despite the shockwaves, we expect that the banking crisis could ultimately prove to be beneficial for global markets for several reasons," deVere Group's Nigel Green said in a note on Monday morning.

Green adds that the "emergency lifelines" that the regulators and governments have provided to the banks have curbed any risk of contagion within the sector and the chances of turmoil spreading across other firms and sectors has been contained.

It all started with the collapse of SVB and Signature Bank in the US. SVB was shut by the regulators on March 10th and put under the control of the Federal Deposit Insurance Corp (FDIC). The FDIC also seized Signature Bank.

Things moved very quickly in the case of SVB - the country's 16th largest bank. As soon as SVB announced it needed to raise capital, customers panicked and rushed to withdraw their money. The speed at which clients withdrew their funds from SVB shows us how quickly a bank run can take place in the digital age.

The Treasury, the Fed and the U.S. President himself rushed to reassure the depositors that their money was safe. However, another crisis was brewing in Europe.

Investors had been watching the slow decline of Credit Suisse over the years, mainly attributed to its accounting errors, its involvement in multiple scandals, several turnaround plans and more. But the SVB collapse exacerbated those concerns as investors started looking around at other banks that could be in a similar position.

"A harsh spotlight has been focused on banks in the last week and while it has been for many of the wrong reasons, it has also "served to highlight to investors that the rules imposed in the wake of the 2008 financial crisis mean that most banks are in a strong position to withstand shocks," deVere's Green said.

That said, banks across the world are still adjusting to the steep surge in interest rates. Lenders had got used to years of low-cost borrowing due to a regime of ultra-low interest rates maintained by central banks around the world. But the sudden increase in rates over the past year has borrowers struggling to manage their portfolios.

"The week ahead looks like a movable feast already, but it seems a safe bet that further central bank intervention is on the cards: and further changes in the global financial architecture, with a larger role for government/regulators," Rabobank said in a research note on Monday.

What's next?

Investors will be watching two big themes in the market over the next few days to understand how the banking crisis is going to play out.

On Sunday, Credit Suisse said that as part of the rescue deal, the Swiss regulator requires almost $17 billion of the lender's so-called Additional Tier 1 (AT1) debt to be written down to zero.

"That appears to have spooked investors and has led to a sell-off in other bank debt and that's weighed on share prices," Russ Mould, Investment Director at AJ Mould said in a research note on Monday morning.

"It means the banking crisis we've seen over the past few weeks has started a new chapter rather than reaching its ending."

AT1 or Contingent Convertible (CoCo) bonds are basically debt securities that would convert into equity when the capital buffers of a bank fall below a certain level. After the 2008 financial crisis, the Bank of International Settlements (BIS) made it necessary for all European banks to hold CoCo bonds.

The second big event this week is the Federal Reserve's interest-rate decision on Wednesday. Most economists and market watchers had been predicting a 25 basis point rate hike from the Fed, taking the US central bank's benchmark rate to 5%.

However, the coordinated action from the Fed and five other central banks on Sunday night is seen by many as a step toward pausing rate hikes. The market has been choppy over the past few weeks and while the central banks, the regulators and the governments have stepped in to contain contagion, there is still a lot of uncertainty over how the high inflation, high interest-rate environment will impact the global economy.

"Central banks know that besides having to try and tame stubbornly high inflation, they also need to ensure financial stability. The events of the last week which rocked confidence will certainly give them cause for pause," deVere's Green said.

"The growing case for interest-rate hikes to be paused will be cheered by global markets."

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