By Nishant Chandra

In a stunning display of unity, six major central banks from around the world have joined hands to reassure investors and prevent a potential banking collapse. This unprecedented concerted effort represents a first for such a move since the Global Financial Crisis of 2007.

It all started with the collapse of three US banks: Silvergate, Silicon Valley Bank (SVB), and Signature Bank. Silvergate, a crypto-friendly bank, announced its liquidation, while SVB was shut down by regulators on March 10 and put under the control of the Federal Deposit Insurance Corp (FDIC). Signature Bank was later seized by the FDIC.

The rapidity with which clients withdrew their funds from SVB demonstrated how quickly a digital-age bank run can occur. Eventually, on March 27, SVB was sold to First Citizens Bank and its UK operations were sold earlier to HSBC for £1.

To address the situation, the US Treasury, the Federal Reserve, and even the US President rushed to assure depositors that their money was safe. Large US banks injected $30 billion in deposits into First Republic Bank on March 16, seeking to rescue the lender after a 70% drop in its share price this month.

Meanwhile, across the Atlantic, in Europe, Credit Suisse’s share price plummeted after its largest investor said it could not provide the bank with more money. The bank had already suffered multi-billion dollar losses related to the collapse of investment fund Archegos and Greensill Capital.

In response, Switzerland’s central bank injected $54 billion to shore up liquidity and investor confidence in Credit Suisse, becoming the first major global bank to receive an emergency lifeline since the 2008 financial crisis. Finally, the Swiss rival UBS purchased Credit Suisse for mere $3.25 Bn, a deal that was approved by the Swiss regulators. The contagion also caught Deutsche Bank whose shares plummeted more than 20% in the last week of March 2023.

The global financial turbulence led to significant stock market declines, with banking stocks experiencing especially steep drops. The banking-sector share slump prompted drops in yields for US Treasuries and Eurozone bonds, while gold prices resumed their recent rally as investors sought safe havens. Moody’s Investors Service downgraded its outlook for the entire banking system to negative from stable due to the failure of SVB and fellow US mid-sized lender Signature Bank.

Corporate defaults are also on the rise in the current tightening monetary environment. S&P Global reported that Europe had the second-highest default count last year since 2009. It expects US and European default rates to reach 3.75% and 3.25%, respectively, in September, compared to 1.6% and 1.4% a year earlier, with pessimistic forecasts of 6.0% and 5.5% not “out of the question.”

The banking sector is facing a critical moment, and the world’s central banks are working tirelessly to prevent a financial meltdown. The question remains whether their efforts will be enough to restore confidence and stability to the markets.

The recent collapse of Silicon Valley Bank (SVB) has been seen by Reuters as a signal that the era of easy cash is over. With higher interest rates dampening investors’ willingness to put money into risky assets, early-stage or speculative businesses are seeing a decline in funding.

Prior to 2022, the Federal Reserve had kept rates near zero, leading banks and financial institutions to purchase a significant amount of their assets in US long-term Treasury Bonds, usually as a relatively easy way to find funding for creditworthy corporates, even during times of quantitative easing.

However, as the Fed increased interest rates, the “yield curve” became inverted, with long-term debt instruments having lower yields than short-term debt instruments of the same credit quality. This inversion is considered by economists as a chief predictor of a recession, and the US has been experiencing it since October, when 3-month rates rose above 10-year Treasury bonds.

The COVID-19 pandemic cost the US $5.2 trillion, with all-in money printing totaling $13 trillion, including $4.5 trillion for quantitative easing and $3 trillion for infrastructure. This massive flush of money eventually causes inflation and asset bubbles, leading to increases in interest rates and reductions in stock values.

Banks, hoping that the Fed would continue its quantitative easing, “binged” on enormous amounts of Treasuries and other long-term bonds in 2021 when the flood of printed money cut off their typical demand for loans. However, upon Fed Chairman Jerome Powell’s re-nomination in November 2021, he hiked rates much faster than anyone had expected, causing the current banking crisis.

In the case of Silicon Valley Bank (SVB), the bank had purchased around $80 billion worth of mortgage-backed securities (MBS) with deposits for its hold-to-maturity (HTM) portfolio. 97% of these MBS were 10+ year duration, with a weighted average yield of 1.56%.

As the Fed raised interest rates in 2022 and continued to do so through 2023, the value of SVB’s mortgage-backed securities declined. Until March 8, 2023, SVB suffered mark-to-market losses and not realized losses, which is not a liquidity issue as long as SVB maintains its deposits.

However, banking is more about perception than about a perfect Asset-Liability match. Once the rumor spreads, every depositor rushes to liquidate/transfer their deposits. The growing demand of panicked depositors all at once asking their money back, forces the bank to sell their bond and MBS holdings at a realized loss.

On March 10, 2022, SVB announced that they had sold $21 billion of their Available for Sale (AFS) securities at a $1.8 billion loss and were raising another $2.25 billion in equity and debt. This came as a surprise to investors who were under the impression that SVB had enough liquidity to avoid selling its AFS portfolio.

To be fair not all banks are plummeting due to hiking of interest rates by the central bankers. Credit Suisse, for instance, was underperforming since many years. Deutsche bank was involved in multiple scandals and was even fined $150 Mn by New York Department of Financial Services.

Overall, while some are blaming the Fed and central banks for increasing interest rates, the real culprit of the Global Financial crisis of 2023 is excessive quantitative easing policy by central bankers for more than a decade, which distorted the prices of assets and created artificial bubbles.

In the aftermath of Lehman Brothers’ collapse in October 2008, the Federal Reserve provided a then-record $110 billion in liquidity to banks within a week through its discount window. This mechanism enables eligible banks to access readily available liquidity from the Fed.

In today’s dollars, that amount equates to $153.8 billion. Fast forward to the week ending March 15, 2023, and the Fed lent $152 billion through the discount window. Additionally, the Fed announced an emergency loan program in response to the SVB failure, providing nearly $12 billion in liquidity.

The inflation-adjusted figures for 2008 and 2023 are quite similar. As such in just a week the Fed reversed roughly half of all the Quantitative Tightening that it accomplished in 12 months. So we see that nothing has changed till date. It’s the same drama all over again.

Not only does this action create asset bubbles and sticky inflation but also ‘moral hazard’. If investors took risks and got returns in the hay days, now when the risk hit, investors shouldn’t ask Central banks and Treasury to support them.

In conclusion, the recent collapse of Silicon Valley Bank and the subsequent banking crisis highlights the vulnerabilities of the financial system and the potential consequences of easy monetary policies.

2023 is shaping up to be a critical moment for the global financial system, marked by a high degree of uncertainty and instability. With unprecedented levels of debt, inflation, and market distortions resulting from a decade of easy money, the world is at risk of experiencing severe shocks and crises. While central banks are working to prevent a financial meltdown, the impact of rising interest rates and increasing defaults on the banking sector and the broader economy cannot be ignored. As the world navigates through these challenging times, it will require a combination of vigilance, innovation, and cooperation to ensure a stable and prosperous future for all.

(Author is Founder, Blocktickets Inc)