Why are Banks in turmoil across the World?

What’s in today’s article?

• Why in News?
• Banking Collapse across the World
• What’s Happening to Banks across the World?
• What is the US Federal Reserve and other Central Banks doing to stop this Banking Collapse?
• What Lies Ahead?

 

Why in News?

• Three major banks, across the world, have collapsed in the past 10 days.

 

Banking Collapse across the World

• Credit Suisse –
  • In a distress sell, Credit Suisse, Switzerland’s second largest bank and one of the most influential banks in global history, was sold to UBS, which is Switzerland’s largest bank and a long-time rival.
  • The deal was hurriedly brokered by Swiss government and regulators in a bid to contain the crisis of confidence in Credit Suisse.
  • The bank reportedly faced withdrawals of close to $10 billion last week.
• Silicon Valley Bank (SVB) –
  • On March 10, SVB, USA’s 16^th largest bank, collapsed after just a single day of stress following a classic bank run in which depositors demanded as much as $42 billion in one go.
• Signature Bank –
  • By the time the US regulators came around to dealing with SVB, another bank called Signature Bank had to be seized after depositors demanded 20% of all its deposits.
  • This made Signature Bank the third largest bank to collapse in the US.

 

 

What’s Happening to Banks across the World?

• There are two ways to look at these bank collapses.
  • One, to look at the specifics of each bank.
    • Case study on Credit Suisse –
      • Credit Suisse has made several risky bets and ended up losing a lot of investor money.
      • That, in turn, has hurt its profitability, eroded investor confidence, and has made raising fresh capital costlier.
      • For instance, Credit Suisse directed many customers to invest as much $10 billion in Greensill Capital.
      • Greensill was itself a lender of sorts — it intermediated between suppliers and clients.
      • But there were increasing question marks over Greensill’s ability to remain solvent.
      • By March 2021, Greensill had filed for bankruptcy, denting Credit Suisse and its rich investors.
      • When Archegos Capital Management, a hedge fund run by Bill Hwang, collapsed, also in March 2021, Credit Suisse lost another $5.5 billion.
      • Such losses were punctuated by high-profile managerial malpractices and exits, further undermining investor confidence.
      • In the case of Silicon Valley Bank too, there is prima facie evidence of both mismanagement and fraud.
  • Two, to look at the Macro Picture –
    • The global economy has had a very long period of loose monetary policy.
      • Loose monetary policy means lots of money being printed by central banks and credit being made available at near zero percent interest rate.
    • This was followed by a sudden and very sharp monetary tightening (read a sharp rise in interest rate across the world as well as reduced money supply).
    • The spike in interest rate is too much and happening all too fast for banks and businesses to adjust and recalibrate their actions.
    • To be sure, economic booms fuelled by extended periods of cheap credit often culminate in economic collapses.

 

What is the US Federal Reserve and other Central Banks doing to stop this Banking Collapse?

• Any financial system runs on trust. If that trust is shaken, things like a bank run can happen.
• To be sure, a Bank Run essentially means all depositors wanting to withdraw their money at the same time.
  • Of course, no bank can furnish such a demand because banks don’t sit on all the money they get from depositors; instead they lend it out to earn some income of their own.
• The collapse of these banks has eroded that trust. People and policymakers alike are worried about the spread of this contagion.
• In particular, the central banks across the world are caught in difficult situation.
• On the one hand their primary mandate is to bring down inflation and restore price stability in the economy.
• On the other hand, they are finding that their sharp monetary tightening is increasingly catching banks and financial players off-guard.
• However, the situation is not as bad as the 2008 financial crisis when the underlying asset itself — the home mortgages — were losing value.
• Key Central Banks, from across the world, have come together to ensure that US dollars can flow from one bank to another in case dollars are needed.
• This is an emergency arrangement and is aimed to not just instil confidence in the consumers but also bolster the confidence of nervous policymakers and bankers.

 

What Lies Ahead?

• The US Federal Reserve and other central banks are acutely concerned about the financial system getting frozen and banks running out of money because of sudden runs.
• In such a scenario, raising interest rates may be considered very risky because it will further raise borrowing costs.
• This week, on March 22, the US Fed will unveil its monetary policy review.
  • First Scenario –
    • If the Fed believes that the banking and financial system is essentially robust and that it can easily deal with one or two faltering banks by providing them liquidity support then it could decide to stick to its path of monetary tightening and possibly raise interest rates by 25 basis points instead of 50.
    • Second Scenario –
      • If it believes the financial system is in grave danger, it may decide to pause.
• Either way, more turmoil is expected in the coming days especially in terms of stock market behaviour.

 

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Q1) What is a Non-Performing Asset?

A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.

 

Q2) What is meant by Bank Run?

A traditional bank run occurs when too many customers withdraw all their money simultaneously from their deposit accounts with a banking institution for fear that the institution may be, or will become, insolvent.

 

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Source: Explained | Why are Banks in turmoil across the World? | Indian Express