The war on inflation claims its biggest casualty so far

For some people in the financial sector, it’s hard to ignore the similarities between this week’s overseas banking turmoil and the early days of the global financial crisis.

What started last weekend with the sudden collapse of a specialist bank in California, Silicon Valley Bank (SVB), soon spread more widely, as regulators also shut down New York-based Signature bank.

Silicon Valley Bank’s collapse caused tremors on world financial markets this week.
Silicon Valley Bank’s collapse caused tremors on world financial markets this week.Credit:AP

Anxiety about the risk of bank runs continued to hover over regional US banks throughout the week, even after sweeping government action to shore up confidence, and a declaration to the nation from President Joe Biden that “your deposits will be there when you need them”.

Investor fears then spread to Switzerland, with markets panicking over global giant Credit Suisse, sparking a plunge in its share price and an emergency loan to restore confidence in the lender.

Shayne Elliott, the chief executive of ANZ Bank, says the outlook is highly uncertain, but there are some “disturbing parallels” with past crises such as the GFC, or even the savings and loan crisis of the 1980s and 1990s, when more than 1000 small US banks failed.

ANZ chief executive Shayne Elliott sees “disturbing parallels” with earlier banking crises.
ANZ chief executive Shayne Elliott sees “disturbing parallels” with earlier banking crises.Credit:Pat Scala

Elliott stresses that it is “extraordinarily early days”, things might quickly resolve, and he doesn’t want to alarm people. But he sees SVB as a high-profile casualty from global central banks’ war on inflation.

The central banks’ only tool in fighting that war has been to raise interest rates rapidly, including here in Australia. That inevitably inflicts some pain.

“If you do that, you will have casualties in that war,” he said. “Those casualties will be businesses that can’t afford to pay, mums and dads that can’t afford to pay.”


He is not the only one noting similarities with past crises.

Fund manager Mike Mangan said there was a clear sense of deja vu for people who had lived through the 2008 global financial crisis, pointing out this week also marked the 15th anniversary of the collapse of US investment bank Bear Stearns – an early failure in the GFC.

“The sudden collapse of SVB is reminiscent of the Bear Stearns collapse on 16 [March] 2008,” Mangan said in his regular email note.

Yet despite these concerning parallels, there are major differences between now and 2008 – most notably the swift and decisive response from regulators to calm the market’s nerves.

Experts are also adamant that Australia’s banks will not face the same serious problems that have hit some smaller US banks this week. Instead, the main impact of the US banking ructions has been on global market sentiment, including a debate over what the turmoil means for interest rates.

A victim of higher interest rates

SVB specialised in start-up technology businesses, but the final trigger for its demise was decidedly old-fashioned: a bank run.

The rapid increase in interest rates played a fundamental role in sparking this crisis of confidence among its customers, alongside a business model that experts say was deeply flawed.

SVB had carved out a lucrative niche serving tech companies during the era of cheap money, which resulted in boom times for many start-ups. Near-zero interest rates meant investors were more likely to invest heavily in speculative ventures, hoping for a long-term pay-off.

But rising interest rates caused this capital to dry up, so more of SVB’s clients started drawing down on their deposits. At the same time, SVB was unusual in two important ways. First, it held much more in deposits than it made in loans. Second, it invested these excess deposit funds heavily in government bonds – assets that have fallen in price as interest rates have risen.

As more squeezed tech businesses started withdrawing their deposits from the bank, SVB was forced to sell assets, and last week it sold a $US21 billion bond portfolio at a $US1.8 billion loss. This loss was the final straw, sparking a collapse in confidence that prompted regulators to shut down the bank within days, marking the second-largest US bank collapse in history.

The sudden failure sent shockwaves around global sharemarkets, including in Australia. But despite these market tremors, bankers and regulators have been quick to highlight major differences between SVB and our banks.

ANZ’s Elliott says the circumstances that brought down SVB simply could not happen here, and he remains “very optimistic” about Australia.

For one, Elliott says Australian banks are forced to recognise any changes in the value of their bond portfolios as they occur through an accounting treatment known as “mark to market”. This means any losses banks make on bonds will not shock investors because they are reported over time.

“If they had been regulated in Australia, those [SVB] losses would have been progressively reported over the last year or so. And so there would have been no surprise and they would have been required to top up capital and liquidity along the way. So it literally can’t happen here,” he says.

Moreover, Elliott says that unlike SVB, Australian banks do not have pools of excess deposits on which they are trying to make a return by taking extra risk in the financial markets. “None of the banks here have excess deposits, so none of us are in that business.”

Local bank analysts backed up this view that Australian banks were unlikely to suffer from rising interest rates as SVB did.

Morningstar’s Nathan Zaia highlighted the concentration of SVB’s deposits in a specific group – tech businesses – and also its high investment in bonds: “We do not believe the conditions that allowed a run to happen on SVB exist for the Australian banks.”

The dramatic failure of SVB has also exposed major cracks in US banking regulation, but local experts have far more confidence in Australia’s regulatory regime.

Regal Funds Management portfolio manager Mark Nathan emphasises that Australian banks are subject to much tighter regulation than the smaller players that have collapsed in the US. He doesn’t believe the episode will lead to major changes in Australia’s banking landscape.

“The regulation and governance around some of the small banks in the US is different to what we have in Australia and what the UK has. Australian banks and UK banks are in a much better position in terms of oversight.”

Systemic risk?

But what about the risks to global markets? Could this week’s turmoil in banking be an early sign a wider crisis brewing in the world financial system?

That is the question investors, bankers and governments are asking themselves after this week’s events – and no one can honestly know the answer.

However, experts say there are critical differences between now and what transpired in 2008, and these provide reasons to be hopeful that the world can dodge a full-blown financial crisis.

Perhaps the most significant difference is the decisive response from regulators, who have acted far more quickly to restore confidence than they did in 2008.

Not only did the US government guarantee all deposits held by SVB – including those above the $US250,000 threshold for insured deposits – it also launched a scheme giving US banks a stream of funding to meet any further demand for withdrawals from the public.

One senior banker not authorised to speak publicly said: “It’s hard to see how they could have done more.”

Elliott says the swift response to SVB’s failure was “dramatically” different to how regulators reacted in the early tremors of 2007 that foreshadowed the GFC, and he says governments learned lessons from the 2008 crisis.

In Switzerland, meanwhile, the country’s central bank allowed Credit Suisse to borrow up to 50 billion francs ($81 billion) to shore up confidence in the troubled giant.

Notwithstanding the problems at Credit Suisse, which has been struggling for years, others also argue the banking problems appear largely specific to the US.

Credit Suisse shares plunged to a record low.
Credit Suisse shares plunged to a record low.Credit:AP

US-based Macquarie analyst Viktor Shvets pointed out bank failures in the US were not that uncommon, as it had thousands of banks and a confusing regulatory structure that was exploited by bank managers as they chased growth. Indeed, he said eight banks with $US672 billion in assets failed between 2018 and 2020 – about three times the size of SVB’s assets.

“Given that the US has about 4700 banks under various charters, regulated by different statutes and overlapping supervisory authorities, it is surprising that failures are not more common,” Shvets said in a note.

But even if this week’s dramas are largely confined to US banks, there are clearly ripple effects being felt around the world, including here. Of most relevance to many households, the episode has prompted predictions central banks may tread more carefully in raising interest rates, for fear of causing more financial instability.

Evans and Partners banking analyst Azib Khan says the decisive response from the US Fed – including turning on the funding tap for banks – creates a “conundrum” for interest rates.

“They are raising rates on the one hand, which is tightening. But then they are willing to inject this money into the system for bailouts. So, what are they doing? Are they tightening or loosening?” he says.

The US Federal Reserve may tread more carefully on interest rates after the recent turmoil in the private banking sector.
The US Federal Reserve may tread more carefully on interest rates after the recent turmoil in the private banking sector.Credit:AP

Markets this week increased their bets that Australia’s interest rates are getting closer to their peak, with some economists predicting a pause next month. Against this, however, recent public comments from the Reserve Bank suggested it thought rates had further to climb.

Elliott says it’s a difficult decision for the central bankers as they go about their war on inflation, but given recent events, he can see the argument for taking a pause and assessing how things settle. “The risk is here [that] you’re just making things worse, potentially. Now, does a month matter? Maybe just take a month and see.”

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