Management of risk is key to a healthy banking sector
South Africans will watch the bank crises that have unfolded in the US and Europe through the lens of our own history of failures over the past couple of decades. That history is one of the reasons SA banks simply aren’t vulnerable in the way US regional banks such as Silicon Valley Bank (SVB) were before they collapsed, triggering loss of confidence across the sector. Nor are their regulators likely to allow a slide as far as Credit Suisse’s before it faced a run on deposits prompting Swiss authorities to force a taxpayerbacked takeover by rival UBS.
SA learned the lessons of its 2002/2003 small banks crisis the hard way, which is why it acted earlier than most countries to tighten up regulation and supervision and make financial stability a core part of the Reserve Bank’s responsibilities. It’s why its banking sector came through the 2008/2009 global financial crisis unscathed. It’s also why it has seen just three banks put into curatorship in the two decades since the small banks crisis, all for specific reasons swiftly resolved.
The US and Swiss crises do highlight pertinent issues for us, though. One of these is about bonds, and the risk they carry. SVB’s travails and those of Credit Suisse seem unrelated. But the link is the very rapid rise in interest rates in the US and Europe after more than a decade of near zero rates, which has led to much tighter funding conditions that expose vulnerabilities in bank balance sheets and business models.
We always say bond yields or interest rates are the inverse of bond prices but often forget what this means in practice: when interest rates go up, bond prices come down. SVB’s problem was that it took in floods of deposits from rich Valley tech companies but couldn’t lend enough, so parked its funds in US treasury bonds. Of course, treasury bonds, and other sovereign bonds such as SA’s government bonds, are considered the safest of all assets and banks are required to hold some to meet their liquidity and capital requirements. But they are not safe from interest rate risk — and in their many years of zero interest rates, advanced markets tended to forget about managing interest rate risk.
In the US it didn’t help that banks such as SVB weren’t required to “mark to market” the value of their bonds, so if they had to sell to give depositors their cash, they suddenly found their bonds were worth way less than the books said they were. It didn’t help either that these smaller regional banks were subject to less regulatory scrutiny than large banks, thanks to Trump era regulatory changes. And as it turned out, the regional banks posed a lot more risk to the system than the regulators had imagined.
SA’s regulatory framework is a lot tighter, and banks and corporates are used to managing interest rate risk. However, the extent to which banks and other financial institutions hold large quantities of government bonds is a source of risk in itself, because it means the health of the financial system is closely linked to the health of the public finances. This “financial sector sovereign nexus” is an issue the Bank and IMF have flagged since the early days of Covid-19, when government borrowing soared at the same time as foreign bond holders sold out, leaving the banks as the 25% main of buyers. SA banks An’IMF assets, study and last while it March estimated government bonds and treasury bills peaked at about found the risk was still moderate, it was reassured that SA’s banking regulator was keeping a careful eye.
Bonds feature in the Swiss crisis in another way: the controversy and uncertainty the Swiss authorities have caused by wiping out Credit Suisse’s bondholders while the bank’s equity holders come out with $3bn. The standard regulatory approach is that equity holders lose everything first when a bank fails, then bondholders, subordinated then senior. In both the US and Europe there have been questions why regulators made the decisions they did; lack of regulatory certainty and clarity is never good for confidence in banks and the legacy of these crises could linger.
Another set of issues the US failures highlight is the tension between competition or inclusion and the stability of the sector. There’s a big debate about the tension between fighting inflation and restoring banking sector stability. The Federal Reserve went ahead with another interest rate hike this week, countering speculation it might hold back because of the crisis, though its backstop measures could pump cash into the economy themselves and hamper inflation fighting efforts.
For SA, though, the pertinent tension is the one between stability and inclusion. More than 20 banks disappeared in the 2002/2003 crisis, half the total number in the sector at a time when regulators were encouraging the entry of smaller players. The famously sound and stable banking sector we have had since has been to some extent at the cost of competition and inclusion. How to foster that without putting the system or depositors at risk is an issue for the Bank, as it is for the sector and economy at large. In the US too, the thriving regional banking sector could yet be the casualty, leaving the big banks to dominate.
One crucial backstop needed is deposit insurance. Two decades on, SA finally has the legislation in place to insure deposits up to R100,000, though insurance has implicitly been there from the government all along. The key is to look after the interests of more vulnerable depositors without making the insurance so generous that it encourages undue risk-taking by the banks and their customers. The US is grappling with that question after temporarily lifting the $250,000 cap on its deposit insurance to make it almost universal, to buffer against the crisis.
One can’t help wondering why so many SVB corporate customers had their deposits and banking in a single institution. Would SA’s corporate treasurers have taken that risk? One of the teachings from each and every banking crisis is how important it is to understand risk, and manage it. That applies as much to customers as it does to bankers and regulators.
LACK OF REGULATORY CERTAINTY AND CLARITY IS NEVER GOOD FOR CONFIDENCE IN BANKS