The first 6 months of 2023 has seen the global banking industry go through its biggest turmoil since the 2008 Global Financial Crisis. California's USD212 billion tech-lender, Silicon Valley Bank (SVB), failed on 10 March 2023, marking the second largest bank failure in US history – the first being Washington Mutual in 2008. The collapse came after a bank run during which SVB's deposit holders initiated withdrawals of USD42 billion, leaving SVB without enough cash or collateral to meet the outflows. The collapse has been blamed on a combination of general mismanagement of the bank, lack of adequate banking regulations and the steep rise in US interest rates. The shockwaves from the collapse of SVB were widely felt and in the weeks immediately following, led to the emergency takeover of Swiss banking giant Credit Suisse.
In March 2023, we reported on the emergency takeover of Credit Suisse by UBS and the highly controversial decision of the Swiss Regulator, FINMA, to write down the bank's AT1 bonds to zero. As expected, in April 2023 investors holding around a third of the USD17 billion AT1 bonds issued by Credit Suisse, commenced legal proceedings. They accuse FINMA of, in part, failing to act in good faith and in a non-arbitrary manner in accordance with Articles 5 and 9 of the Swiss constitution when it used emergency powers (conferred by the Swiss government) to cancel the AT1 bonds on 19 March 2023.
The European Central Bank and the Bank of England were quick to issue statements in the wake of the collapse of Credit Suisse to reassure the public with the latter stating, "UK banking system is well capitalised and funded, and remains safe and sound." Nonetheless, the collapse of reputable banks such as Credit Suisse highlight the ongoing vulnerabilities in the banking sector and the threat of a recurrence of the 2008 banking crisis.
Some commentators point towards the rapidly rising interest rates worldwide - an attempt to combat the soaring inflation rates - as a cause for concern. In the UK, the Bank of England has increased interest rates 13 times since December 2021 and the base rate currently sits at 5% with the possibility of a further rate increase by the end of the summer. Whilst rising interest rates can be positive for savers, who make higher returns on their saving accounts, conversely it is negative for mortgage borrowers and those investing in longer-term government bonds and securities, which are inversely correlated with interest rates and reduce in value.
Rapidly rising interest rates mean banks either suddenly have vast loan books with interest rates fixed far below the current interest rate or loans at variable rates which can be increased but with every increase comes the risk of borrowers defaulting on repayments they can no longer afford. The current instability in interest rates worldwide plus the soaring inflation mean greater market instability with investors trading cautiously, lower loan demand and higher funding costs. As was seen in the case of SVB, the drastic rise in interest rates and corresponding fall in the value of long-term securities could also cause bank runs which could lead to the collapse of even highly rated banks with a solid balance sheet.
Some regard with trepidation the current government's calls for a relaxation of the financial regulations put in place following the 2008 global banking crisis. The crisis led to the enactment of thousands of pages of regulation worldwide. On 8 December 2022, HM Treasury unveiled an extensive set of regulatory proposals focused on reforming regulation retained from EU law and replacing them with a new framework for the UK financial services sector – the so called Edinburgh Reforms. The proposals include reforms to the current rules on bank ringfencing – which is where retail banking functions used by UK customers are separated from other, riskier, investment banking arms – to remove banks without major investment banking activities from the regime and amending the deposit threshold for the scope of the ringfencing rules. Other initiatives include reducing regulatory requirements concerning information documents and presentational formats, removing rules for the capital deduction of non-performing exposures held by banks, establishing a new class of wholesale market venue to operate on an intermittent trading basis as a bridge between public and private markets.
Some have heralded the reforms as necessary to maintain the competitiveness of UK financial services and markets worldwide. On the other hand, particularly following the financial turmoil this year, others are calling for tighter rules to ensure a stable framework to manage and oversee banking risks. The collapse of SVB exposed holes in US regulation as to how smaller lenders are overseen. People such as Klaas Knot, Chair of the Financial Stability Board (FSB) and President of the Dutch Central Bank, have called for "FSB members [to] remain vigilant and stand ready to take policy measures to maintain the resilience of the global financial system."
The impact of either the relaxation of banking regulation or the tightening of regulation to increase oversight over banks remains to be seen and we continue to monitor the implementation and results of reforms such as the Edinburgh Reforms. Banks need to identify the risks they face in order to manage effectively the risks of further instability. Litigation following banking failures may lead to the banks and fund managers seeking indemnification for claims and defence costs in connection with investigations and proceedings. Beyond that, insurers may need to manage their direct risk to further collapses by assessing the impact on the loss of value of any investment security against the company's financial strength and stability.
