22 March 2023

Finance Watch: A Reaction to the Banking Crisis: Reinforce international prudential and resolution rules

Here we go again. Pouring public money onto the flames of the latest bank failure. Clearly, the international rules adopted since 2008 are not sufficient to make for a stable system and moral hazard remains the dominant principle in banking.

This should be a wake up call. Financial authorities must properly implement and reinforce international prudential and resolution rules for banks.

After three bank failures in a single week and despite super-sized emergency support by global central banks, trust in banks is vanishing once again throughout financial markets. Why is this happening now, and how is this even possible, when so much has been done to strengthen banks after the 2008 crisis?

No more trust, no more bank

By design, banks are not in a position to immediately pay back all of their customers’ deposits at once. The minute customers lose confidence in the safety of their deposits, the stampede starts and banks collapse. This is exactly what we saw in the past few days.

Silicon Valley Bank’s customers queued up to get their deposits back while the daily deposit outflows of troubled Credit Suisse topped CHF 10 billion. Two otherwise incomparable scenarios happening days apart. There is one common denominator among banks such as Silicon Valley Bank and Credit Suisse: Where there is no more trust, regardless of the reason, there is no more bank.

From a systemic standpoint, the essential question is not why Silicon Valley Bank was foolish enough not to hedge the interest rate risk on its portfolio of bonds deemed “available for sale” (hedging costs money, of course); nor is the question why Credit Suisse has been jumping from one crisis to the other for several years (greed and lack of adequate governance, of course).

We must ask ourselves, instead, why and how the failure of three banks – representing less than 0.5% of the world’s banking assets (if we include Signature Bank) – is capable of threatening the entire system.

Post-2008 rules not properly implemented

Does the fact that all banks are now under pressure indicate that participants in financial markets, who are well-informed and knowledgeable about the banking system, do not trust that prudential rules are sufficient to ensure systemic stability?

The short answer is yes. Investors do not believe that the prevailing rules are sufficient to stabilise the system, and here are two main reasons for this....

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