12 June 2024

SUERF's Saldias, Scheicher: How do financial markets’ view risks in the global banking sector? A heatmap with a novel thermometer

Against the background of stress in the global banking system in spring 2023, we introduce a methodology to analyse how traders view risks in the banking sector. Our System-wide Bank Risk Sentiment Tracker (“sBRST”)1 relies on information from equities, credit spreads and options.

We find that traders were surprised by the materialisation of banking risks last year. We also observe rapid shock transmission. At the time of writing, stress indicators continue to hover above their historical means.

The March 2023 banking turmoil was the most significant stress event for European and US banks since the Great Financial Crisis in 2008. It started with the forced takeovers of Silicon Valley Bank, First Republic and Signature in the US, which were organized after an unprecedented digital run, and culminated in the sale of Credit Suisse, a Globally Systemically Important Bank (GSIB), to UBS. The bank failures, while having largely distinct causes, triggered a wave of question marks about the resilience of banks across multiple jurisdictions. This article applies a new and comprehensive methodology to assess the markets’ perception about risks in the banking sector in the euro area and the US. Our main finding is that despite improvements in markets’ risk sentiment towards banks there is still lingering awareness about risks in the banking sector in markets due to persistent vulnerabilities that banking macro and micro supervision need to continue monitoring and addressing.

1. Introduction

In the aftermath of the stress in spring 2023², pockets of vulnerability persist in the global banking system. According to Adrian et al. (2024), more than 30% of banks – including some of the world’s largest – are vulnerable in the medium term if the global economy would enter a period of stagflation. Commercial Real Estate lending is seen as a potential source of significant losses in the near-term in the US (Jiang et at., 2023).³

Financial market perception is crucial for banks, as the Credit Suisse episode has most recently highlighted. Banks depend on capital and derivatives markets for issuing equity and bonds, secured and unsecured funding, trading of safe assets and hedging of interest rate risks. Against this backdrop, close and timely monitoring of the market signals about the banking sector is important to launch early interventions, thereby avoiding the materialisation of contagion in the banking system as investors catch-up with vulnerabilities in banks’ fundamentals and business models. As the Credit Suisse episode showed, the widespread use of banking apps together with social media can increase the speed of bank runs and ripple effects on vulnerable banks and trigger negative spillovers across markets. This faster transmission of stress calls for improvements in the toolkit of central bank monitoring of risk in individual banks and system-wide.⁴

We use a new and comprehensive methodology to analyse markets’ perception of bank risk over the last ten years. Major advantages of the System-wide Bank Risk Sentiment Tracker (“sBRST”) are that it uses a very comprehensive set of market information as input, its straightforward interpretation, and its responsiveness to idiosyncratic and systemic events to monitor risk in the banking sector.

Comprehensive monitoring of investors’ risk sentiment towards banks is crucial to ensure supervision can react in a timely manner to emerging stress build-up and facilitates prompt policy responses. During periods of stress, risk sentiment may manifest across various markets simultaneously, with varying degrees of magnitude. This helps in assessing the duration of necessary monitoring and assessing the effectiveness of policy action.

Our empirical analysis yields the following insights. First, we find that before stress events last year, risks in the banking sector were perceived as low and below the long-term mean. Second, the speed of shock transmission in March 2023 was very high, with EU bank risk perception rising very fast. Third, stress indicators have fallen significantly in the meanwhile, but are still above their long-term means....

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