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Who’s Scared of the Next Banking Crisis?

Investors in financial markets were shaken in March by the collapse of several large banks in the United States and Switzerland. Andrew Kenningham considers if this may be the start of a new global financial crisis.

4 September 2023

It’s not surprising that the collapse of several banks in the US and Credit Suisse in Switzerland has raised fears of a repeat of the global financial crisis (GFC). After all, that crisis began with a few medium-sized banks getting into trouble. And although that was 15 years ago, it’s still fresh in our collective memory.

Watch the speed

While there are similarities with the GFC, the problems in March introduced some worrying new elements. One is the speed at which deposits fled, reflecting the prevalence of internet banking and the role of social media. Customers of Silicon Valley Bank withdrew $42 billion in a single day, whereas the previous largest bank run came in 2008, when customers withdrew $16.7 billion from Washington Mutual Bank over 10 days.

Another is that the regulations set up after the last crisis didn’t work. It turned out that some large US banks were not subject to the toughest health checks established back then partly because the CEOs of several banks, including Silicon Valley Bank, had successfully lobbied to be exempt. And some of the banks which failed in March had actually passed the financial health checks only a few weeks earlier.

But how bad might this year’s problems become? There are several big differences between the situation now and 15 years ago which provide some reassurance.

Risk awareness

For a start, there are no significant losses on the banks’ loan portfolios this time round. In contrast, back in 2008 the underlying problem was that millions of Americans had taken out loans to buy properties only to find they could not afford to service them.

Another major problem in 2008 was that these loans had been distributed around the financial sector in ways which were ridiculously complicated and opaque. Nobody knew where the losses were and that created a climate of fear in which banks refused to lend to one another. This time there doesn’t seem to be such large, hidden losses.

And third, the regulators are now far more aware of the risks. The US moved quickly to guarantee the deposits of its failing banks and Switzerland forced a takeover of Credit Suisse by its long-time rival, UBS. This nipped any contagion in the bud.

So a repeat of the extreme events of 2008/09 seems highly unlikely. However, even a less-severe banking crisis could cause problems.

Crises with a history

Ever since modern banking was invented there have been bank failures, bank runs and banking crises, but their implications for the wider economy have varied.

At one end of the spectrum the collapse of Britain’s biggest investment bank, Barings, in 1995 had no wider economic ramifications. (It had big implications for Nick Leeson, the rogue trader who caused the collapse, as he spent four years in prison.) At the other end of the spectrum is the global crisis of the early 1930s that contributed to the Great Depression in the US and is arguably one of the factors which created a fertile environment for fascism in Europe.

The most relevant historical cases today are probably in between these extremes. One example is the savings and loans (S&L) crisis in the US in the 1980s when thousands of relatively small US banks made losses on their mortgage loans and about a third of them ended up going bankrupt.

The problems in the 1980s were partly caused by the Fed raising interest rates as this forced the S&Ls to raise deposit rates in order to discourage people from moving their money elsewhere.

The S&L crisis ended up being very expensive for the US. But it was a slow-burning problem which did not prevent the US (and global) economies from performing quite well overall.

Who’s swimming naked?

Nobody knows how this year’s problems will pan out. More problems may yet emerge, particularly if the world economy heads into recession as a result of higher interest rates. As the legendary investor Warren Buffett put it, it’s only when the tide goes out you discover who’s been swimming naked.

Economists worry about the risks with commercial property loans given there is so much empty office space with people still working from home. And in Europe there is a risk of trouble in the government debt market.

But for now it seems more likely that any banking problems will be limited to specific institutions and will not morph into a sustained or systemic banking crisis.

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