Key Takeaways
- Credit Suisse's collapse sparked concerns among investors, causing a significant drop in bank shares.
- The Bank of England (BoE) and the European Central Bank (ECB) assure investors their sectors have enough liquidity and regulatory measures to remain secure.
- Higher interest rates meant to curb inflation are raising concerns about the ability of small and medium-sized enterprises (SMEs) to meet their debt obligations.
The collapse of Credit Suisse and subsequent worries
The recent collapses of the Silicon Valley Bank and, to a bigger extent, Credit Suisse have brought a lot of attention into the health of the EU and UK banking sectors, with a short-lived sell-off of bank stocks exacerbating fears of a looming banking recession.
Overall, the state of the EU and UK banking sectors seems to be solid, with the only short-term risk being the self-fulfilling lack of investor confidence.
EU and UK politicians and regulators are trying to reassure investors that the banking sector is resilient, with banks being well capitalised, having ample cash on hand and sufficient “sticky” deposits (i.e. people who aren’t planning to take their money out).
Attention turns to German banking
Following the collapse of Credit Suisse, negative investor sentiment geared towards Deutsche Bank, which lost a quarter of its share value within a month. The stock prices of several French and British banks also took a dive, reflecting subdued investor confidence following the Credit Suisse collapse.
German Chancellor Olaf Scholz said that there’s no reason for concern, as Deutsche bank has recently reorganised its business model and its profitability is growing at the fastest pace ever. The German banking sector remains resilient, with commercial, savings, mortgage and developments banks performing fairly well.
Crisis prevention is at the forefront of central bank efforts
The Single Resolution Board (SRB) is the central resolution authority within the Banking Union, which is made up of 20 eurozone countries and Bulgaria. It was set up after the 2008 financial crisis to make sure eurozone banks are prepared for a collapse so that shareholders and creditors bear losses in a failure, rather than the taxpayer.
Dominique Laboureix, the chair of the SRB, said the EU’s rules and toolkit to deal with failing lenders would be able to cope with “all types of banking crises” without having to withdraw public money.
The Fed has joined the BoE, Bank of Canada, Bank of Japan, European Central Bank and Swiss National Bank in a coordinated action to boost the ability of central banks to inject capital to private banks through US dollar swap line arrangements. Swap lines enable two countries to make currency more readily available for central banks to lend to private banks enough funds to ensure they can pay out to customers in case of mass withdrawals.
The BoE reassures investors and raises interest rates
In the aftermath of the Credit Suisse collapse, the BoE assured investors that the UK banking system is well capitalised and funded and remains safe and sound. It also welcomed the acquisition of Credit Suisse (one of the City’s biggest employers) by UBS, saying that it supports financial stability.
In pursuit of further stability, the BoE is considering boosting the deposit amount covered for businesses, forcing banks to pre-fund the system to a greater extent to ensure prompt access to cash when a lender collapses.
In late-March, the BoE hiked interest rates by 25 basis points to 4.25%, as the UK economy grapples with unprecedentedly high inflation against a backdrop of post-Credit Suisse concerns over the EU and UK banking system.
The Monetary Policy Committee voted 7-2 in favor of raising the bank rate after Office for National Statistics data showed that UK inflation (measured by the Consumer Prices Index) unexpectedly rose by 10.4% in the 12 months to February 2023. The rise of interest rates aims to reduce the supply of money in the economy, reducing business and consumer demand with the ultimate aim of curbing inflation.
The future of indebted SMEs looks fragile
Turmoil in the banking sector is raising uncertainty over the inflation outlook, with banks expected to tighten lending criteria, weighing on consumer demand and business investment, and alleviating inflation pressures when combined with rising interest rates.
However, this could prove to be a double-edged sword for the fragile post-Brexit UK economy, with the British Chambers of Commerce saying that the latest rate hike will put pressure small UK businesses, which are now battling with both rising input prices and borrowing costs. Rising default rates on SME loans could trigger further instability in investor confidence in the UK banking sector.
As the BoE previously reported, the average cost of borrowing for SMEs has nearly doubled from a rate of 2.5% rate at the end of 2021 to 4.7% in 2022 – and it’s only continuing to climb.
The BoE reports that since 2019, total outstanding SME debt has increased by around 20%, while the proportion of SME debt in arrears increased from 2% to 2.4% in 2022.
The BoE expects defaults on all types of loans to continue to grow amid rising interest rates. Many SMEs indebted themselves during and in the aftermath of the COVID-19 outbreak in a bid to survive, but now have to pay much higher debt payments every month, pushing many to default on their loans and forcing some out of business.
Final Word
Overall, although the collapses of US banks and Credit Suisse triggered a wave of negative investor sentiment towards the global banking sector, the ECB and the BoE have publicly stated that there’s enough liquidity and regulatory instruments in place to deal with potential bank collapses and different crises scenarios. Recent collapses seem to be isolated and a result of long-term and pre-existing company strategies rather than the result of a looming global financial crisis.
Nevertheless, ever-rising interest rates are creating well-founded investor concerns over the state of the global banking sector and its ability to deal with things going wrong.
