Without lucidity, there is no problem solving. It should therefore be said that the banking crisis is serious. Denial would be catastrophic. In a few days, we witnessed the second and third biggest bankruptcies in American banking history (Silicon Valley Bank and Signature Bank), the American banking authorities had to guarantee all of the deposits of these two establishments, the The Fed (the American central bank) had to set up an emergency loan plan for the banks, the same Fed must review its program to fight inflation, 11 banks intervened to save one of their own (First Republic bank).
In Europe, the ECB has so far not changed its policy, but the Swiss Central Bank has lent just over 50 billion euros to Credit Suisse. Admittedly, the financial markets have herding and self-fulfilling behavior. But psychology and mimicry, if they amplify the crises, are not enough to sum up what has just happened. The events of the past few days have fundamental and identifiable causes. The American (and to a lesser extent European) banking system is shaken by the exit from the world of interest rates at 0%, even as technological innovation blurs economic benchmarks and the Internet accelerates banking crises.
Let’s review these three points (rate 0, technological innovation, Internet banking) and analyze their interactions to fully understand what is currently at play in the depths of the banking and financial system.
The strategy of private equity players: “sprinkle wide”
With the Covid pandemic, monetary policy has moved to a so-called “fiscal dominance” regime. What economists mean when they use this expression is that monetary policy has lost its de facto independence, guided by the imperatives of budgetary policy and the absolute will not to risk a State becoming insolvent. The pandemic has led almost all developed countries to implement exceptionally large spending programs to protect businesses, compensate short-time working, increase health spending. These increases in spending were largely financed by public debt, particularly in Europe. Even if the ECB does not have the right to lend directly to States, it can help them indirectly, for example by buying sovereign bonds from banks or insurance companies, to avoid any risk of public default. It also has an influence on the ability of States to run up debt by setting the level of short-term interest rates. This setting of interest rates at zero or even negative levels has an influence on the entire yield curve. Thus, when the markets are almost certain that the central banks will leave their rates at 0, the longer-term rates (five or ten years) relax spontaneously.
Episodes of fiscal dominance had preceded the pandemic, for example in 2012 when the situation of Greek public finances was almost desperate and the situation of Italian public finances was deteriorating. But it was at the time of the Covid crisis that zero or even negative interest rates allowed States, but also the financial sphere, to benefit from exceptional financing conditions. The onset of inflation, partly linked to this very expansionary monetary policy, radically changed the environment, which trapped the Silicon Valley Bank (SVB). This Californian bank had Silicon Valley start-ups as clients whose cash it housed. With the increase in short-term interest rates implemented by the Fed to fight against inflation, the SVB had to increase the remuneration of deposits. Its assets consisted mainly of government bonds, the value of which melted with the rise in interest rates. Indeed, a bond bought two years ago and yielding 0% sees its value fall when it becomes possible to buy exactly the same type of bond but with an interest rate of 3.5%. The SVB saw the value of its assets collapse even though it had to remunerate the deposits recorded in its liabilities and honor the requests for withdrawals (the bank run).
The banking crisis is part of the context of the third industrial revolution, which is that of the convergence between digital technologies, artificial intelligence, robotics and biotechnologies. As in any Schumpeterian cycle of creative destruction, the changes brought about by innovations are not only technological but also economic. THE business models are undergoing ruptures: music, the media, cinema, distribution and even the automobile industry have been greatly shaken up by these industrial revolutions. In these periods, the valuation of companies becomes complex, the factors of success or failure more difficult to identify. Hence the strategy of many private equity players, which is to “water wide”, hoping that one successful investment will finance the losses of nine failed investments.
A “big cleaning” as painful as necessary
This strategy becomes more complex to implement when the cost of financing for private equity players increases with the rise in interest rates. Capital funders, who have fewer resources, then become more selective. And the ecosystem of start-ups is experiencing a “big cleanup” as painful as it is necessary. Here we are ! It was against this tense backdrop that Silicon Valley investors advised their companies to withdraw their deposits from the SVB and put them in a safer bank, triggering the crisis. SVB was unable to recover enough cash to meet the withdrawals by selling bonds that had collapsed in price. This context of creative destruction is only a secondary difficulty for the financial system, compared to the rise in interest rates. But it adds a dose of uncertainty and anxiety that was less present during the 2008 crisis.
The third industrial revolution also directly affects the banking system. We know that in finance, speed is the enemy of good. This is why there are “circuit breakers” on the financial markets: when the value of a security suddenly collapses, its price is temporarily suspended so that everyone can come to their senses. Smartphones make it possible to carry out a banking transaction in swiping. In 2008, the bank runs were materialized by queues in front of vending machines. In 2023, the bank runs are done from a smartphone in seconds. What is striking since the beginning of this crisis is the speed of the chain of events. Banking applications have their share of responsibility, not in the outbreak of the crisis, but in its brutality.
This speed hit the American banking and financial authorities (the Fed, the Treasury, the supervisors), who reacted very quickly by insuring all the deposits of the failing banks and providing more liquidity to the banking system. Shareholders must lose their stake, but not savers. The non-rescue of Lehman Brothers on September 15, 2008 and the slowness taken by the national authorities to save the other banks is still on everyone’s mind. It is also fortunate that a large number of people currently in charge experienced the horrors of 2008 when, to use the expression of Nicolas Sarkozy, then Head of State, “the world economy was empty of his blood”.
The systemic risk of chain bank failures should be avoided, precisely because 2008 is still on everyone’s mind and because the authorities are doing the right thing. On the other hand, it is possible that we will experience a global contraction in the supply of credit (which has already started in certain sectors such as real estate). Banks will have to increase the value of their capital, remain very liquid, reduce their risks: credit will undoubtedly be more scarce in the coming months, or even in the coming years.