As soon as news emerged that Silicon Valley Bank (SVB), the 16th-largest lender in America, with about $200 billion in assets, had collapsed, a dark cloud loomed over the international financial sector. Even when the initial shock started to wear off following swift action from central banks, the dust has not settled yet on the collapse of SVB and Credit Suisse.
Various pieces are still moving on the financial chessboard. Sergio Ermotti returned recently to UBS, the bank that merged with Credit Suisse. Officially, Ermotti will help the bank navigate what was a hasty takeover. Critics quickly pinpointed the fact that he was brought back from his relatively easy job at Swiss Re because of his capacity to handle difficult situations and firefight, which means that there is still much work to be done. Meanwhile, Ammar Al-Khudairy of the Saudi National Bank, whose comments led to investor panic that caused the emergency takeover, has resigned.
At this point, a financial crisis on the magnitude of 2008-2009 does not seem likely, but the recent turmoil still confirms one thing: global financial markets are fragile and prone to crises. Since this is the case, as Paolo Pasquariello, Professor of Finance at the University of Michigan, put it, “We need to make the system as fire-proof as feasible while being ready to extinguish fires when they occur.”
Firefighting is exactly what central banks have done so far, offering credit lifelines and tumbling bank shares. The Swiss National Bank facilitated the UBS takeover of Credit Suisse. Since the fire seems to be put out, “One can start worrying about catching any arsonists,” observed Pasquariello.
Now it is time to make life as difficult as possible for financial arsonists and, more importantly, to make the financial markets as fire-proof as possible. Ironically, though, the bankers who were responsible for the crisis to begin with are those tasked with stabilising the financial markets.
It is important to note that the relaxation of banking and finance regulations in the US is one of the main reasons behind SVB’s collapse. During the Donald Trump presidency, some banking regulations were rolled back through the Economic Growth, Regulatory Relief and Consumer Protection Act, which was signed into law in May 2018. Specifically, some rules put in place after the 2008 financial crisis to prevent another financial collapse were softened or eliminated, such as those related to executive compensation and capital requirements for smaller banks. This rollback has been criticised by some, including Senators Bernie Sanders and Elizabeth Warren, for potentially increasing the risk of another financial crisis.
This self-fulfilling prophecy by the aforementioned senators is what happened with SVB. Because of the softening of regulations, the latter accumulated risks which reached an unacceptable point, leading to its collapse.
In sum, easing regulations was the cause, but the cure is still to be found in regulations. Stricter limitations will prevent risks, but they must also be well-calibrated in order not to create unnecessary costs for the banks.
However, regulations are only one side of the coin. The other is inflation. Increasing interest rates to fight inflation is another trigger for the current banking crisis. Higher rates made it difficult for SVB to finance itself and damaged the value of its loans and assets. Ultimately, this led to the bank’s collapse.
Paradoxically, without regulations and policies, the economy would also suffer. The problems would come in the form of a recession or, worse, stagflation, leading to more bank collapses. Hence, policies such as increasing interest rates can be problematic for some actors, but, ultimately, they lead to the preservation of the system by keeping the economy running.
One thing is worth remembering while analysing and drawing lessons from this crisis: every action and inaction, be it for putting out the fire or making the system fire-proof, will have consequences. Central banks’ efforts to address the crisis have their flaws. Above all, such actions might encourage banks to take excessive risks knowing that there will be a helping hand from the central banks. However, “In absence of these actions, we ordinary citizens would be much worse [off]: long lines to withdraw whatever is left of our deposits; unemployment; a depressed housing market; and less easy access to credit to fund economic activity,” warned Pasquariello.
The same logic applies to (in)actions to prevent future crises. Such measures will be costly, for sure, but there will be benefits in them too. What states and central banks need to do right now, therefore, is to assess costs and benefits and act upon them before it is too late.
The views expressed in this article belong to the author and do not necessarily reflect the editorial policy of Middle East Monitor.